The jobs report today was a strong one, underscoring the ability of the US economy to power through. Am I uneasy about where we are in the economic and credit cycle and the accuracy of the Fed’s forward guidance? Yes – and I tend to think most of the risk is to the downside. Even so, there is a Goldilocks scenario in the data that I think is achievable. Let me outline that scenario here.
What we saw from the jobs report today was +292,000 non-farm payrolls in December and upward revisions to November and October, bringing November to +252,000 and October to +307,000. That’s an average of 283,000 jobs. That’s a pretty good number. To put this in context, we averaged about +221,000 in 2015. So the last three months are well above. An average of +221,000 is a good number. And +283,000 is even better. The unemployment rate was unchanged at 5.0%
Bottom line: the US employment market is doing just fine right now. Yes, jobs are a lagging indicator. Nonetheless, upward revisions and the positive delta between the 3-month and the 12-month rolling average are not lagging indicators and they are indicative of economic support.
So, despite my general outlook being one where the risks are to the downside to the point where even recession is possible, I think there is a Goldilocks scenario possible here.
First, the Fed is hiking rates right now. Futures for April Fed Funds are at about 48 bps, suggesting one further rate hike between now and then. That’s supportive of the US dollar. And a strong US dollar is negative for EM, for commodities, for oil and for high yield and leveraged loans. But it is also potentially supportive of credit growth.
In a Goldilocks scenario, consumers try to lock in borrowing at lower rates now, in anticipation of higher rates down the line.This means borrowers would be pulling forward borrowing decisions and pushing up credit growth while the energy sector works through its problems. This also means – with job growth fairly robust – the baton to do the heavy lifting of maintaining economic growth is passed to wage growth and residential construction from capital spending and non-residential construction.
I’m not saying this scenario is the one that will result in 2016. I am pointing out that it is a potential outcome to the upside. My baseline right now is 2% growth for 2016 with enough tail risk to make recession a possibility as the Fed hikes interest rates. But the Goldilocks scenario is one in which we see 3% growth and accelerating wage growth as the Fed raises rates.
The biggest risk to the Goldilocks scenario is corporate earnings. Right now we are at the beginning of the third consecutive contractionary quarterly corporate earnings season. You don’t see wages rising when corporate earnings are contracting. And the wage number in this latest jobs report was down slightly. But a 3% wage growth number is still doable in a situation where household credit growth is robust.
My view: the economy remains on a track that is consistent enough with the Fed’s overall outlook that we should expect more rate hikes and a strong US dollar. How this impacts the Chinese currency, commodities, energy and high yield will have a meaningful impact on the economic picture. However, at the same time, we need to watch US credit growth to understand how well the US economy can overcome downside risks.