The Goldilocks employment report

April's job gains were strong enough to keep a rate increase on the table for September but weak enough that a June increase looks highly unlikely.

Robert Johnson, CFA 11 May, 2015 | 5:00PM

Equity markets performed much less in step this week as Europe was up 1.2%, the United States just 0.11%, and emerging markets were down 1.2%.

Generally, forecasts and news out of Europe seemed to indicate at least some improvement, while U.S. growth seemingly slowed a little more, and economic data out of China and fears of a slowing in the United States held back emerging markets. Relative strength in Europe and a new belief that additional QE might not be necessary pushed European interest rates sharply higher. This had a knock-on effect on U.S. rates, which have generally moved higher--the U.S. 10-Year bond yield now stands at 2.12%. Morningstar bond strategist David Sekera has been saying for some time that recent negative interest rates in Europe didn't make any sense on a fundamental basis as traders bought bonds at negative yields in hope of selling them to other traders at even lower rates. It took just a whiff of growth to almost instantaneously pop interest rates in Europe.

In economic news, the world purchasing manager data from Markit were a bit weaker than earlier flash reports, especially for China. Chinese trade growth also is now expected to be smaller in 2015 in a separate report out of China. In the United States, the trade report was a disappointment, creating some worries relative to GDP growth for the first quarter and the year.

The April employment report for the United States was right on target and at least partially erased the horrible report for March along with immediate worries that the United States was moving back into a recession. The bad news was that the March numbers were revised down and that wage growth was surprisingly lethargic, especially given all the high-profile wage rate increase announcements. Still, the jobs report was strong enough to keep a rate increase on the table for September but weak enough that a June rate increase looked highly unlikely, a fact that the markets loved on Friday when the Dow soared by over 267 points.

Jobs report another mixed bag that kept markets happy

The U.S. employment report wasn't so strong that it created worries about economic overheating and Fed tightening, and it wasn't so weak that it created concern that the economy was about to slide back into a recession. Headline growth of 223,000 jobs matched expectations and represented a nice bounce back from the dismal March numbers. However, it wasn't all good news; the March estimate was reduced from 126,000 jobs added to just 85,000, providing a much easier set of goalposts to hit for the April report. Furthermore, hourly wage growth, at least on a month-to-month basis, was surprisingly weak with just 0.1% growth or 1.2% annualized. The year-over-year averaged data looked significantly better, with 2.2% growth with or without inflation, which was close to zero. This should help keep consumers in a good mood.

Unfortunately, the employment trends built up in the first quarter will be difficult to overcome over the course of the full year. Total nonfarm payrolls grew by an unusually strong 260,000 jobs per month in 2014. Now, for the first four months of 2015, job growth has averaged just 194,000. That will make it hard to hit my full-year forecast of 250,000 jobs. Therefore, I am reducing my job growth estimate to a range of 220,000 to 240,000 jobs with a single-point estimate of 230,000 jobs for the full year (and 248,000 jobs for each of the eight remaining months of the year). That represents job growth of approximately 1.9% for the full year. Both the number of jobs added and the growth rates in those jobs are likely to be modestly less than in 2014 as slowing job growth in the energy patch and the manufacturing sector are only partially offset by better potential in the housing and health care sectors.

Turning to the details of the April report, the year-over-year data is not nearly as bleak as some of the recent month-to-month numbers. Looking at private sector job growth, which excludes the much slower-growing government sector, the three-month average, year-over-year growth rate remains relatively high at 2.6%, which is down just a touch from recent highs and still above the 2.4% average growth rate of the past 12 months. Those year-over-year growth rates are likely to continue deteriorating modestly in the months ahead.

However, the number of employees added is only part of the equation. Hourly wage gains are almost as important as the number of employees when determining total wage growth, which is the most important indicator of consumer spending. Hours worked also need to be considered and those are trending lower. On the margin, hours worked growth has slowed the most while employment growth and hourly wage growth rates have been much higher but have changed little. Hourly wage growth is still stuck in the same 2.0%-2.1% rate that it has been in for the past 12 months. Though adjusting for inflation, the hourly wage rate has been generally trending up. Considering all components of wage growth -- employment, wage rate and hours -- growth is healthy but trending modestly downward.

Now taking inflation into account, the combined wage growth total seems to have plateaued, but at a rate roughly twice that of a year ago at this same time. And the economy accelerated nicely in the back half of 2014, despite that seemingly low wage growth rate of last April. In sum, a lot of positive employment metrics look like they have plateaued, some at very healthy levels. We suspect that many of those metrics will deteriorate as prices begin to move back up and employment slows. Wage growth should do better in the months ahead but that has yet to really kick in as we had hoped. Despite what feels like some deterioration in some employment data, the consumer has yet to spend many of the gains of the past four or five months as savings soared to well over 5%. Perhaps some of that caution was well-placed, but we still suspect that some of those savings will end up as increased spending in the months ahead.

Losing faith in the average wage calculation

Though the year-over-year wage data was right on recent trends, the month-to-month data looked anemic at 0.1%, which when annualized, is half the rate of the 12-month trend. Month-to-month data is volatile and subject to a lot of lumpiness, as we have said before. So normally I might just blow off the month-to-month data. However, with increased minimum wages at employers  Wal-Mart WMT and  Target TGT as of April 1, I was anticipating a big pop. For some reason, there wasn't.

With 500,000 workers (about 0.5% of private payrolls) getting a 20% or more boost at Wal-Mart, allegedly on April 1, I thought wage growth would have been up 0.1% on just that one factor, without any growth at any other company. Even the retail numbers wages, where Wal-Mart represents a bigger percentage of the total, were only up their typical 0.2% month to month. Maybe the wage increase will show up next month or in a future revision.

Furthermore, some of the hourly wage data says more about the mix of jobs and certain industry problems than individual perceptions of hourly wage growth. For example, the month's hourly wage number was held back by a rather large decline in the energy sector. The transportation and warehouse sector, as well as the catch-all "other" category, was also down. Health care hourly wages, which were also flat, don't square with much better employment trends for those workers. The year-over-year data makes a little more sense, but is still subject to mix issues. One other point worth mentioning is that wages for restaurant and hotel workers are on fire (maybe unlike Wal-Mart,  McDonald's MCD minimum wage increase did make it into the report). Year-over-year wage growth for this sector is up a stunning 3.9%, compared with an all-category average of 2.1%. Even on a month-to-month basis, wage growth was up 0.6% (7.2% annualized) for food and hotel workers.

Unemployment falls for all the right reasons

The U.S. unemployment rate continued to trend down, ending April at 5.4%, down from 5.5% a month ago and 6.2% a year ago. This is the lowest reading in seven years. For a change, the rate went down exclusively because new jobs were added even as 166,000 people entered the work force in April. The higher percentage of people looking for jobs is a sign of increased consumer confidence.

Short-term U.S. trade data leaps higher; not nearly as bad as it looks

The financial press is having a field day with the recent trade report, breathlessly noting that the March trade gap jumped a stunning 46% from US$35 billion to US$51.4 billion, the largest single-month widening in more than 20 years. Well, that conveniently leaves out the fact that the February number was one of the best trade deficit numbers in a long time, too. Averaging February and March data, the deficit was little changed. Also, not often mentioned, was that almost all of the short-term gyration is due to container ships from China that were unable to unload cargo in February. Then they were emptied en masse during March because of labour actions and the late February resolution of the West Coast port issue. The impact is clear: Looking at data from China, imports surged by US$11 billion in a single month after several months of relative lethargy. (Goods from China come in primarily at West Coast ports.)

As usual, the year-over-year data provides a more accurate view of the trade situation.

As one might suspect, given all the recent headlines, export growth has slowed and imports have accelerated. The data above represent inflation-adjusted data (the headline report is not inflation-adjusted), three-month averages of year-over-year growth rates for goods only. On the export side, a lot of pundits are making a big deal about the higher dollar and lack of U.S. competitiveness. There is some truth to this, especially in the highly currency-sensitive auto sector that saw a meaningful decrease in exports over the first three months of 2015. A lot of the other reasons for slowing were a little quirkier and not directly affected by the currency. Food showed a huge slowdown year over year, but that was related to less-severe weather conditions around the world and less to do with competitiveness. And as we have noted before, a lot of the slowdown in exports was related to equipment that processes commodities, which are now suffering a severe contraction, no matter where the equipment to produce those commodities was manufactured. Year-over-year import trends also worsened, but not as severely as the export data.

Net exports will hurt GDP growth

Actual March trade data is not available before the GDP estimate, which forces the government to estimate the March results. Though it correctly guessed that imports would soar in March and exports wouldn't move much, even it was too conservative in its estimates. Their underestimation of imports and overestimation of exports is likely to force the government to reduce its first-quarter estimate of GDP growth down by 0.5% from a positive 0.2% to a minus 0.3% if viewed in isolation. However, many of those extra imports will find their way onto inventory shelves which causing inventory levels to go up, potentially adding to GDP. My best guess is that first-quarter GDP growth will end up around zero, down from the original 0.2% estimate. However, inventory effects are nearly impossible to estimate.

Looking to the full year, exports added 0.4% to GDP growth in each of the past three years. For all of 2015, exports might not add anything to GDP growth. Imports are also likely to be a bigger detractor from the GDP calculation than they were in 2014, further hurting the 2015 GDP calculation. Combining imports and exports, the swing factor/headwind could be as much as 0.5%, which is a large number relative to our GDP estimate of 2.0%-2.5%.

Federal budget surplus larger than expected in April

The budget surplus for April, a big month for tax collections, came in a whopping US$40 billion higher than expected just a few months ago. Higher nonwithheld income taxes (likely capital gains tax payments due on April 15) were the primary reason for the outperformance. Overall expenditures other than health care remained under tight control in April while tax collections continued to soar.

Overall collections were up 8.9% while expenditures were up a slower 6.1% for the first seven months of the fiscal year. That caused the year-to-date budget deficit to shrink by US$22 billion. Expenditures, excluding the benefits from Fannie and Freddie payments, were up only 4%. This was without any major surprises (like last year's special student loan provision or this year's prescription drug true-up). The budget deficit could come in at US$430 billion or less, substantially better than the March estimate of US$480 billion. That would bring the deficit in at about 2.5% of GDP, which is well below long-term averages. The bad news is that the tax collections have gone up enough to begin to have an impact on spending.

Home prices surge in March amid low inventory levels and high demand (by Roland Czerniawski)

The latest report from  CoreLogic CLGX showed that home prices continued to rise at a much faster pace than previously expected, growing 2.0% in March compared with February. On a year-over-year basis, the growth stood at 5.9%, the fastest pace since July. CoreLogic predicts that prices will rise 0.8% in April, and that the year-over-year growth will tick down to 5.4%. In terms of three-month moving averages, we see a visible up-trend since the prices appeared to temporarily bottom in the beginning of the year.

Unusually low inventory levels and a coinciding increase in demand are driving the prices of existing homes higher. This issue is especially prominent in the South, as the Houston and Dallas areas in Texas saw nearly double-digit year-over-year growth in March. Faster-growing prices are both good and bad news. The bad news is that the higher pace of home price increases will almost certainly put a dent in the affordability of existing homes, which is something that has the potential of slowing down the housing recovery.

The good news is that it is reassuring to see many new buyers who feel financially secure and confident enough to buy a home, even at higher prices. Faster price growth also helps existing homeowners to emerge from their underwater mortgages. According to CoreLogic, current home prices are still 11% below their peak from April 2006. More important, as faster-growing prices hurt the affordability of existing homes, the demand might shift toward new homes. The gap between existing-home prices and new home prices had grown unusually wide and declines in that gap could bolster the construction sector. That in turn could provide a direct boost to the GDP and employment. We think that home price isn't likely to exceed 6% this year, although the risk of a more severe pricing spiral, such as the one we saw in 2013, cannot be ruled out. CoreLogic predicts that the growth will moderate later this year and that the prices will increase by about 5.1% from March 2015 to March 2016.

Retail sales main item on the docket for next week

From December to February, consumers were huddled up in their homes, not spending much on anything new. March looked much better. Headline retail sales had a nice month-to-month increase in March, led by auto sales increasing 0.9%. Now with the modestly disappointing numbers for April released, expectations are for retail sales to be flat. Excluding autos, retail sales are expected to be up 0.5%. That would be relatively similar to the 0.5% growth rate for sales less autos and gasoline in March. I actually think that the month-to-month ex-autos and gasoline number could be even better than the consensus at 0.6% or 0.7% given the improvement in weekly shopping centre sales. Given that exports, government and businesses are doing little on the increased spending front, we really need to see the consumer step it up in the April report.

Industrial production: more pain from energy and utilities

Industrial production can't seem to catch a break. Lately, mild weather has held the report only with components related to the oil industry. With both mining and utilities down, it will be very hard for industrial production to stay in positive territory even if manufacturing manages to show some growth. The consensus forecast for headline industrial production growth is a negative 0.3% following a drop of 0.6% in March.

Other reports of interest: JOLTS and small-business optimism

Job openings have been trending higher for many months and are currently running near an all-time high of 5.1 million (February). With the job growth trend slowing it will be very interesting to see if those openings will remain above 5 million in the report on March. With the Small Business Sentiment report we will be watching the jobs that are difficult to fill metric, along with salary increases, both actual and planned.

About Author

Robert Johnson, CFA

Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis for Morningstar.