The Market Today
Earnings Growth Accelerates in August as Labor Market Remains Strong
by Craig Dismuke, Dudley Carter
Strong Job Growth Continues in August: Nonfarm payrolls grew 201k in August, a stronger-than-expected result; economists expected 190k payrolls added. June’s payroll tally was revised down 40k to +208k while July’s tally was notched lower by 10k to +147k. The 3-month moving average is now 185k, the slowest rate of the year but still strong given slower population growth. Private payroll growth accounted for all of the new jobs, up 204k while government sector jobs contracted 3k. Despite the strongest ISM Manufacturing index since 2004, the manufacturing sector lost 3k jobs in August. The retail sector also shed 6k jobs while IT lost 6k. Stronger sectors included education and health (+53k versus 12-month run rate of +37k), business services (+53k versus +43k), and transportation (+20k versus +14k). The construction sector added 23k jobs, in-line with the 12-month average of +25k.
Unemployment Rate Inches Lower: The household unemployment rate ticked lower from 3.87% to 3.85% (rounded to 3.9%) as fewer people reported as employed, fewer people reported as unemployed, and fewer people reported as being in the labor force. The number of persons reporting as not in the labor force increased 692k while the number of employed declined 423k. Given historical volatility of the household data, the fractional nature of the decrease in the unemployment rate, and the divergence in the monthly data from recent trends; it is hard to make too much of the August data.
Earnings Hit Fastest Growth Rate of Cycle: Earnings growth remains the focus for markets and Fed officials, and August’s earnings data were strong. Average hourly earnings rose 0.37% MoM bringing the YoY rate up to 2.92%, a new highwater mark for this cycle. Earnings were expected to hold at a 2.7% YoY growth rate. Faster wage growth was fairly widespread with seven of eleven sectors showing faster growth than their 12-month trends. Adding to the strength of the earnings figures, hours worked held steady at 34.5, meaning the stronger wage growth was not the result of a smaller denominator in the earnings/hours worked calculation. Interestingly, the two sectors performing worst in job growth also saw the biggest increases in earnings, highlighting the challenge for some sectors to fill open jobs and the consequential need to increase wages. Earnings in the IT sector rose 0.63% MoM while retail earnings increased 0.64%.
September Hike Highly Likely Given Strength of August Labor Data: Heading into the September 26 FOMC Meeting, all signs now point to another 25 bps rate hike. Even those Fed officials who have raised concerns about weak wage growth will likely be more amenable to a hike given the strength of the August earnings data. Market focus will now turn to December and the potential for a fourth hike in 2018. For now, investors are pricing in approximately a 50% chance for a December hike.
Population Dynamics Underscore Real Strength of Labor Market: With the exceptions of 2012 and 2013, the country is now growing its 16-65 population at the slowest rate since WWII, adding just 38.7k per month according to Census Bureau data and projections. Given the weaker labor-age population growth, the recent run of job growth has had an even larger impact on reducing slack from the labor market. From 1950 to 2010, payroll growth averaged a rate of 83% of labor-age population growth. Since 2012, payrolls are growing at 4.5 times the labor-age population growth rate.
Yesterday – Another Day of Tech Weakness and a Drag from Energy Companies Pushed Equities, Treasury Yields Lower: The Nasdaq led losses in U.S. equities for a third day in a row, with its 0.9% drop easily eclipsing a 0.4% decline for the S&P 500 and a 0.1% move up for the Dow. The tech sector fell 0.8% and remained a drag on the S&P 500, but was bettered by energy companies for the bottom spot on the sector ladder. Energy companies sank nearly 2% after the price of crude and other energy commodities fell following the release of the weekly EIA inventory report. Crude inventories contracted a larger-than-expected 4.3MM barrels, but distillate stocks surged to lift total inventories by 3.6MM barrels. In addition, a measure of demand slowed after two strong back-to-back weekly increases. The equity weakness set the tone for the Treasury market early, with the Nasdaq’s 9 a.m. CT plunge pulling yields down to their lows of the day. Yields had nudged modestly lower after an ADP miss, but more than doubled their decline as stocks sold off and were near the lows at the close. The 2-year yield closed 1.6 bps lower at 2.64%, 5-year yield fell 2.7 bps to 2.74%, and the 10-year yield dropped 2.9 bps to 2.87%.
Overnight – Trade Uncertainty Keeps Investors Cautious Before Jobs Report Surprises with Strong Earnings: Global investors remained watchful overnight after the window opened for the U.S. to possibly make good on threats against another $200B of Chinese imports and before this morning’s U.S. jobs report. President Trump indicated last Thursday that he could be ready to implement the tariffs as soon as the day after the public comment period. While that comment period expired at midnight, there have been no reports or headlines discussing the U.S.’s next move. Chinese stocks were a bright spot in another mostly-down day for Global equities. The U.S. also resumed talks with Canada this week to try and bridge the divide that is currently keeping Canada outside of the new U.S.-Mexico deal agreed to early last week. President Trump said yesterday he expects Canada will join a new, more “fair” NAFTA deal but a Canadian official noted that, despite additional positive progress this week, a deal is unlikely by the end of Friday. The Canadian Dollar recovered modestly for a third day. European stocks were trading near their lows of the day which had helped keep downward pressure on U.S. futures. Ahead of the nonfarm payroll report, U.S. futures were down 0.2% while Treasury yields had moved up by between 1.2 and 1.5 bps. After the cycle-best hourly earnings figure was released, Treasury yields more than doubled up their overnight rise with the entire curve moving up more than 4 bps. Equity futures sank and the Dollar spiked to its highest level of the day.
Better-than-Expected Services Survey Rounds Out Strong Month for ISM Reports: The ISM Non-Manufacturing PMI topped estimates in August just two days after its sister report covering U.S. manufacturers surged to an 18-year high. Many of the underlying themes were consistent across the two reports with gains in new orders (+3.4 points) and business production (+4.2 points) contributing the most to the non-manufacturing PMI’s improvement. Employment (+0.6 points) and supplier delivery times (+3.0 points) provided more modest boosts. Other underlying indexes showed less price pressure, stronger exports but weaker imports, and the third largest backlog of orders during the cycle. Putting the August report into a longer context, the rebound to 58.5 put the headline PMI right in line with its 2018 average which is towards the top of its cyclical range. In the comments sections, several sectors cited negative impacts from tariffs, one was struggling to find workers, but most said activity was strong. Overall, the ISM reports showed another strong month for the U.S. economy in August.
Business Investment Remained Solid in Disappointing Factory Orders Report: Factory orders were weaker than expected in July, but not because of softer trends in the important business investment categories. Total factory orders slipped 0.8% in July but rose 0.2% when the volatile transportation categories were adjusted out. Orders for aircrafts, both private and public defense, dropped roughly 35% while auto orders rose 1.3%. Consumer goods orders were up 1.1%, the durables category rose 3.8%, while already-strong orders and shipments to businesses were revised even stronger. Non-defense capital goods orders were revised up 0.2% to 1.6% in a signal of solid economic activity to come. Shipments of the same were 0.1% stronger after the initial estimates were fine-tuned, reinforcing the strength in prior business investment in equipment in the second quarter.
Williams Not Necessarily Worried about Inverting the Yield Curve: NY Fed Bank President John Williams, now a perennial FOMC member and voter on policy, acknowledged the current strength of the U.S. economy by saying, “In a way it’s a bit of a Goldilocks economy from a policy maker point of view.” The fact that “we are not seeing inflationary pressure,” means “We can continue to be relatively patient and allow this economy to continue to grow.” He expects the unemployment rate to continue trending lower and admitted “It’s still a little bit of a puzzle” as to why wages haven’t picked up more. He noted the Fed is on the right path and doesn’t “feel the need to raise interest rates more quickly than otherwise.” In a May interview, Williams indicated support for three or four hikes for all of 2018. Williams also addressed the tension between more planned Fed tightening and the flattening yield curve, noting “I would expect in any tightening cycle like this to see some flattening of the yield curve, so I don’t think that’s particularly extraordinary.” He added “In terms of monetary policy decisions, I just think we need to make the right decision based on our analysis of where the economy is, and where it’s heading, in terms of our dual mandate goals. …If that were to require us to move interest rates up to the point where the yield curve was flat or inverted, that would not be something I would find worrisome on its own. …I don’t see the flat yield curve or the inverted yield curve as being a deciding factor in terms of thinking about where we should go with policy.”
Evans Caveated His Call for Restrictive Policy, Evidencing Considerable Uncertainty Policy Makers Face: Chicago Fed President Evan (2019 voter) was scheduled to give a speech on monetary policy in Argentina on Monday, but the event was ultimately cancelled. The Chicago Fed, however, released it in written form on its website Thursday afternoon. Two times Evans said policy may need to become restrictive and two times Evans immediately balanced that belief with a caveat. In his prepared remarks, Evans was to say “Given the outlook today, I believe this will entail moving policy first toward a neutral setting and then likely a bit beyond neutral to help transition the economy onto a long-run sustainable growth path with inflation at our symmetric 2 percent target.” The next two paragraphs, however, explained how that could change depending on what headwinds or tailwinds actually emerge. In his conclusion, after rehashing the median policy path from the June dot plot, Evans said “this path has policy becoming a bit restrictive sometime next year and tightening a touch further in 2020. Given an unemployment rate forecast below the natural rate, such a policy stance is quite natural and would be consistent with some moderation in growth and a gradual return of employment to its longer-run sustainable level.” But, again, Evans followed it with the caveat that “Of course, in the end, actual policy will differ from this path depending on the headwinds and tailwinds arising from the various shocks that inevitably will hit the economy.” Despite the uncertainty Evans showed, he seems comfortable with idea of the overnight rate becoming restrictive.