The latest jobs report came in at 160,000 jobs added to US non-farm payrolls. As this number was below expectations, it effectively sidelines the Fed in June. And given we are in an election year, the chances of two rate hikes occurring are lower than they otherwise would be. Meanwhile, the US economy’s growth trajectory has slipped below the 2% stall speed level. And we will have to continue to wait for more evidence regarding its future direction.
Let’s look at the numbers first and talk about what they might mean.
First, the headline numbers were 5.0% unemployment and 160,000 jobs added. In comparison to the last year’s data, these numbers were middling.
A lot of people are talking about the 160,000 number as soft because it was the lowest in seven months. But my concern is not a single number but a cumulative trend and here are the relevant charts on both rolling year-over year non-farm payroll gains and year-over-year uptick in the seasonally adjusted unemployment rate.
Now the first chart is all about getting a sense of where we are in this cycle. We saw an energy slowdown-related fall in payroll growth from early 2015 on. But recently, that fall has been arrested and the trend is not clear. If the rate of payroll growth continues to fall, we should see this as an income shock that would further reduce GDP growth.
The second chart is my attempt to show you a long time series on this kind of year-over-year data. And what you will see if you click to zoom is that the year-over-year change in the unemployment rate trends up for a while before recessions hit, meaning the unemployment weakness does not lag recession if you parse the data this way rather than just looking at the rate of unemployment in isolation. For example, in the 1990s, and the 2000s, the rate of decline in the unemployment rate slowed well before recession. And here it is the 2nd derivative that was a leading indicator, not the unemployment rate itself, which lags. The 1980s is the best example because of the mid-1980’s mid-cycle pause. You can see a massive uptick in the change in the unemployment rate in the early 1980s, to the point that by mid-1985, the unemployment rate had stalled on a year-over-year basis. This is a sign of economic weakness that is associated with recession. But in this case, it was a mid-cycle pause rather than a recession.
And the reason for this is because economic growth was really high at the time. Year-over-year real GDP growth was 8.5% after Q1 1984 and it decelerated a lot but only to 3.7% in mid 1985. Here’s the chart.
By contrast, right now the economy is already at stall speed below 2% GDP growth, with this cycle’s absolute top at 3.07% in Q3 2010. Growth rates in the US in this century have simply been much weaker.
So what do I think the numbers mean?
First, they mean that we are indeed in a period of so-called secular stagnation. Real GDP growth rates have been weak for an entire 16 year period. The highest we got was 4.4% in 2004 during the housing bubble as rates were held at 1%. This cycle topped out even lower, at 3% with rates lower still, 0%. If that’s not secular stagnation, what is?
Second, on a cyclical basis, it is not clear to me that we are heading into recession quite yet. The GDP numbers say stall speed.
The unemployment claims say no recession as they have not even ticked up yet. Jobs numbers say there is more weakness than the headline 5.0% rate would imply but nothing there is screaming recession.
Third, these numbers put the Fed on hold. A month ago I asked “Is the Fed panicked about the downshift in the US economy?” and my answer was that the Fed was alarmed but not panicked.
As a reminder, I wrote the following:
“…the economy is so weak now that the Fed may not be able to even hit its target of two rate hikes, a target that was reduced from 4 hikes for 2016 predicted just in December. That’s astonishing really. Think about it for a second. Literally four months ago the Fed was telling us things were so good that we should expect 300 basis points of hikes over three years. That’s twelve hikes in three years. Now they are saying they may not be able to get a single hike off the table – so weak is the economy.
“To me this speaks to policy error. Basically the Fed tried to start hiking in December and it ran into a buzz saw, not just from economic weakness but financial fragility and global monetary policy divergence. And so now its hands are tied.
“The right question now is: how weak is the US economy?”
And that is still the question. My answer here is that it is at stall speed and not near recession.
What we need to be watching is how the slowdown in earnings (three quarters if falling earnings, five quarters of falling revenue) hit business spending and job growth. My overall view here is that non-residential business spending will be weak for the foreseeable future and the year-over-year jobs numbers will continue to weaken. Energy is played out. I think autos are exhausted too. And unless we see an uptick in pay, I am sceptical general consumer aggregate demand is not going to reverse that trend.
At some point, the question will be what sector of the economy can do the heavy lifting. Will it be housing? We’ll see.
But the Fed is not hiking into this environment unless it wants to repeat December’s policy error. For now, that’s bond bullish as the 2-year yield hit a record low after the jobs numbers came out on the view the data mean no hikes. But the news is not necessarily bullish for US equities because the fundamentals are weak both on revenue and earnings. While I still hold out hope for a mid-80s style mid-cycle pause, my overall view continues to be that we are nearer the end of the cycle.