Stocks defy jobs Econoday Simply Economics 5/8/00 By Evelina M. Tainer, Chief Economist

Volatility is always the name of the game
Stock prices sold off early in the week as news of strong economic fundamentals spurred fears that the Fed would become more aggressive in their near term rate hikes. Prices fell sharply on Tuesday and Wednesday. According to market analysts, the employment report was virtually ignored because stock investors had already priced in a 50 basis point rate hike in their expectations. But some market strategists felt this was a short-term phenomenon. Investors appeared to focus on the fact that such robust economic data point to improved corporate earnings no matter what interest rates do. Many expect investors to re-think the situation in the coming week. In the meantime, all major indices rose on Friday despite the robust employment report.

However, not all indices posted gains for the week. Despite today’s favorable trading session, the Dow, the NASDAQ composite and the S&P 500 all decreased from week ago levels. The Russell 2000 is up from a week ago. The chart below suggests that all the indices seem to be clustering around the same spot. Actually, only the Russell 2000 is above 100 – which means it is the only index that is higher from yearend. The S&P 500 is a close second – and only 2.5 percent below yearend levels.

Economic fundamentals: back in the saddle again
The Treasury market followed the pattern set in the previous week. Strong economic data were uniformly bearish for Treasury securities this week. Whether it was comments by Federal Reserve officials or economic indicators, bond investors were generally on the side of the bears. Economic indicators support the view that Fed officials could easily decide to raise rates more aggressively at the May 16 FOMC meeting. For the most part, investors are pricing in such a hike. In fact, if the Fed were to only raise rates by 25 basis points, bond investors would now worry that the Fed was behind the curve and inflationary pressures might eventually get away from them. As soon as the Fed announces a rate hike on the day of the FOMC meeting, market players will start worrying about the next move.

Notice in the table below that the 10-year note and the 30-year bond yields increased more sharply this week relative to the 2-year and 5-year notes. Last week, the reverse happened with larger gains at the short end of the curve. This partly reflects the issue of supply. Treasury officials announced borrowing schedules, but just like early in the year, the official words coming out of the Treasury weren’t consistent from one day to the next. Thus, the 30-year bond yield rise partly reflects questions about the intended supply of new 30-year bonds as well as buybacks of old bonds.

 

Markets at a Glance
Treasury Securities	12/31/99	April 27	May 5	Weekly Change
30-year Bond	6.48%	5.96%	6.19%	+ 23 BP
10-year Note	6.43%	6.22%	6.51%	+ 29 BP
5-year Note	6.34%	6.54%	6.75%	+ 21 BP
2-year Note	6.24%	6.67%	6.82%	+ 15 BP
Stock Prices
DJIA	11497*	10739*	10578*	- 1.0 %
S&P 500	1469*	1452*	1433*	+ 1.2 %
NASDAQ Composite	4069*	3861*	3817*	+ 6.0 %
Russell 2000	505*	506*	513*	+ 5.0 %
Exchange Rates
Euro/$	1.0008	0.9121	0.8979	- 1.6 %
Yen/$	102.40	108.18	108.33	+ 0.1%
Commodity Prices
Crude Oil ($/barrel)	$25.60	$25.70	$27.15	+ 5.6 %
Gold ($/ounce)	$289.60	$284.80	$280.40	- 1.5 %
(BP = basis points; stock price indices are rounded)

Robust employment any way you slice it
Nonfarm payroll employment jumped 340,000 in April after a 458,00 gain in March. Once-in-a-decade Census hiring boosted both months. Even after taking into account this special factor, there is no question that employment gains were still robust! Gains were registered across the board with the exception of construction payrolls, which likely corrected from a first-quarter spurt that was caused by unseasonably warm weather. Some analysts pointed to the April spurt in retail trade as a special factor, but retail trade employment had been more modest in the past several months, possibly making this a catch-up month. Even after searching for reasons to downplay the report, one simply can’t make the case that employment growth is anything but healthy.

Payroll data was not the only series from this report that showed strength. The civilian unemployment rate fell to 3.9 percent – the lowest rate since January 1970! Perhaps even more disconcerting to Federal Reserve officials than a jobless rate under 4 percent might be the sharp drop in the pool of available workers, a series recently promoted by Alan Greenspan & company. Though the series is only available back to 1993 on a monthly basis, it goes back to 1970 on a quarterly basis. The April level is at its lowest since the third quarter of 1974! Fed officials won’t take this lightly.

Soon after the employment situation was reported, President Clinton claimed that the employment report was "wonderful news". No question that’s true from a worker’s standpoint. Also good news for workers was a 0.4 percent gain in average hourly earnings for the third time in four months. On a year-over-year basis, hourly earnings rose 3.8 percent. But from the standpoint of the Federal Reserve, they see increasing labor demand coupled with declining resources and accelerating wages. Notice in the chart above how hourly earnings are on a rising trajectory.

The bottom line on employment? Every major series coming from the employment report pointed to the same conclusion: economic growth has strong momentum that hasn’t been stilled by five 25 basis point rate hikes in the past year. If wage pressures had not accompanied employment demand, Federal Reserve officials would have no business trying to cool down this red-hot economy. At it stands, wages are accelerating on a monthly and yearly basis. The April employment report makes a good case for more aggressive Fed action. Fed officials may have spent some time debating the merits of a 50 basis point rate hike at the last FOMC meeting; the debate may be more one-sided in favor of 50 basis points at the May 16 meeting.

Productivity moderates, but still shows good growth
Nonfarm productivity rose at a 2.4 percent rate in the first quarter after growing at an average 6 percent rate in the second half of 1999. The first quarter pace seems paltry in comparison, but is quite healthy from an historical perspective – particularly at this late stage of an expansion. Moreover, on a year-over-year basis, productivity increased 3.7 percent, the same as the fourth quarter and the fastest rate since 1992. Market players were disappointed with first quarter productivity figures only because they came in slightly below expectations. Viewed in a broader perspective, the figures are still robust.

Unit labor costs in the nonfarm sector rose at a 1.8 percent rate in the January to March period after declining at a 2.9 percent rate in the previous quarter. Once again, the figures are more sanguine when looking at the year-over-year change, rising 0.7 percent in the first quarter. Note in the chart above that unit labor costs are climbing at their slowest rate since mid-1996. These are hardly cause for concern.

The bottom line on productivity? From a long-term historical perspective, the productivity and costs figures were actually pretty favorable. However, there was nothing in the data to suggest that the momentum on productivity and costs will be on the improving side. While Greenspan & friends can’t deny that productivity growth has exceeded expectations over this expansion, they can’t predict or feel comfortable that the strong growth will continue. Moreover, Greenspan is also worried that favorable productivity figures will get built in to stock valuations which will in turn spur wealth and consumer demand. All in all, the productivity data won’t be sufficient to maintain the current gradualist approach to Fed rate hikes.

Bits and pieces: the consumer
New home sales jumped 4.5 percent in March to 966,000, the highest pace since November 1998. Despite the boost, total sales (including existing) were down in the first quarter. Indeed, the quarterly chart below shows a clear downward pattern of housing activity since the peak in this cycle which occurred in the second quarter of 1999. The chart also depicts the strong inverse correlation between home sales and mortgage rates. The rising rates did slow down housing activity, although perhaps not to the degree that economists and policymakers would have expected based on historical trends. The mortgage rate actually peaked in February at 8.31 percent and has since fallen to 8.15 percent as of April.

The other big-ticket item purchased by consumers also moderated in April. Auto and truck sales both peaked in February and have moderated since. However, as indicated in the chart below, the level of motor vehicle sales are still high relative to the past year. Fed officials would surely like to see a more dramatic cooling off.

Bits and pieces: manufacturing
Factory orders jumped 2.2 percent in March after decreasing the previous two months. New orders were generally higher in the first quarter relative to the fourth quarter pace. The key, though, is that the growth rate of factory orders has accelerated the past two years; note the trend indicated in the chart below. The NAPM survey edged down slightly in April, but remains well above the 50 percent mark. These two series both suggest that industrial production could post healthy gains in the next few months. While the consumer sector was booming in the past few years, manufacturing activity was relatively anemic. The accelerated rate of growth bodes well for the manufacturing sector, but this could be another source of anxiety for the Fed. Incidentally, the accelerated wage gains in the past several months are coming from manufacturing. Service-sector wages have remained rather stable over the past six months.

THE BOTTOM LINE
On the whole, this week’s set of economic news was generally indicative of robust economic activity. Few of the indicators showed significant moderation from the torrid pace of the previous quarter. Even after accounting for Census hiring, there is no question that the employment situation revealed very healthy but tight labor market conditions. Wages are trending higher. Moreover, the anecdotal evidence noted in the Beige Book was generally consistent with the April employment report.

A few key indicators are yet to be reported before the FOMC meeting. These include both of the inflation measures (PPI and CPI) as well as retail sales and housing starts. All will be quite important in helping Fed officials decide how to proceed on cooling down the economy. At this point, bond and stock investors are probably pricing in a rate hike of 50 basis points for the May meeting. Whether the Fed will continue a more aggressive policy in June and beyond has not been an issue yet for market players. But as soon as the May 16 rate hike is announced, the question will turn to the next FOMC meeting at the end of June.

Looking Ahead: Week of May 8 to May 12
Market News International compiles this market consensus which surveys about 20 economists each week.

Thursday
Market participants are expecting new jobless claims to decrease 18,000 in the week ended May 6 from last week's 303,000 level.

Economists are predicting retail sales will record a 0.4 percent gain in April after a modest 0.2 percent rise in March. Excluding the volatile auto group, sales are also expected to rise an anemic 0.4 percent gain. This reflects sluggish demand at chain store sales.

Friday
The market consensus is looking for a drop of 0.3 percent in April’s producer price index. The PPI is now benefiting from a drop in energy prices. Remember, though, that the PPI jumped 1 percent in each of the two previous months. Excluding food and energy, economists are predicting a 0.1 percent gain in the "core" PPI, the same as last month.

The market consensus shows business inventories rose 0.3 percent in March, less than the 0.5 percent gains of the two previous months. This incorporates the flat inventory figure for manufacturing.

Week of May 15 to May 19
Early forecasts show that industrial production is expected to gain 0.8 percent in April after more anemic gains the past two months. This incorporates the gain in factory payrolls coupled with a rise in the average workweek. As a result, the capacity utilization rate should rise to 81.8 percent, up 0.4 percentage points from the March.

As a preliminary look, economists are expecting a 0.1 percent gain in the CPI in April, much less than the 0.7 percent gain posted in March. Excluding food and energy, the CPI should rise 0.2 percent – half as much as the previous month.