The Market Today
Powell Nominated; Tax Plan Unveiled; Lack of Earnings Growth Casts Cloud Over Job Rebound
by Craig Dismuke, Dudley Carter
Today’s Calendar – October Job Growth Rebounds from Hurricanes, Weak Earnings Growth Adds to Dilemma for FOMC: Nonfarm payrolls grew 261k in October, rebounding from the hurricane-decimated September report. While the headline number was 52k lower than economists’ estimates for 313k payrolls, this is not a big concern. Rebounds from one-off events tend to be volatile and hard to predict. Moreover, September’s -33k report was revised up to +18k while August’s +169k was revised up to +208k. With the +90k in revisions to the previous two months’ reports, 351k total payrolls were added in the data released this morning. Private payroll growth increased 252k, including 24k additional manufacturing jobs. The 3-month average for total payroll growth is now back up to 162k despite the anomalous September data and has now averaged 169k per month in 2017.
The unemployment rate pulled an old trick, dropping from 4.22% to 4.07% on another big exodus from the labor force. The number of people reporting as “not in the labor force” rose 969k while the number of employed fell 484k and the number of unemployed dropped 281k. There were further signs of less slack in the labor force with long-term unemployed falling 112k and those working part-time for economic reasons down 369k. Going forward, the question will be if any of the people who have left the labor force altogether will come back. If so, there is ample slack in the form of non-participants.
The unfortunate kicker to the October labor data was a very disappointing average hourly earnings report. Earnings were flat month-over-month (exp. +0.2%) bringing the year-over-year rate of growth back down from 2.9% (rev. 2.8%) to 2.4% (exp. 2.7%). The construction and transportation sectors led the decline, down 0.4% and 0.2% MoM respectively. However, 10 out of 11 industry groups saw weaker earnings growth in October than in September. Utilities was the only sector with fractionally better growth and that is likely to reverse in coming months as the hurricane repairs are completed.
Bottom Line: The September jobs report shows continued, strong job growth; a resumption of the concerning labor force exodus (at least for one month); and weak enough wage growth to rekindle the Fed’s growing concern that weaker inflation is broader than initially expected. While this is unlikely to derail a December hike, it will likely yield deeper discussions at the Fed about the possibility that rate hikes should be slowed.
Overnight Activity – Markets Mostly Quiet Despite Thursday’s Flood of U.S. Economic News, Friday’s Payroll Report: Global markets were mixed overnight after a heavy day for U.S. economic news on Thursday, most notably details of the tax plan and a Fed Chair nominee, and ahead of this morning’s U.S. jobs report. Sovereign yields moved in different directions but most curves were little changed. The two outliers are in the U.K. and Australia where economic news pushed those curves to the top and bottom of the day’s global extremes. Yields in the U.K. fell sharply Thursday after the Bank of England dovishly raised rates for the first time in more than 10 years. Overnight, however, the short-end popped back to recoup some of those losses after a strong October services PMI. Yields in Australia tumbled and are the low-side outlier after a disappointing retail sales report. The U.K. Pound is the day’s best performing currency while the Aussie Dollar has dropped to the lowest rung on the global currency ladder. Ahead of this morning’s payroll report, the Nasdaq was leading U.S. equity futures higher thanks to a big earnings beat from Apple on Thursday after markets closed. The Treasury curve and U.S. Dollar were essentially unchanged. The initial market reaction of lower yields and a weaker Dollar showed investors looked past the solid hiring to the weak hourly earnings print and the plunge in participation that dropped the unemployment rate to an almost 17-year low. Shorter yields quickly recovered with the 2-year yield back to an unchanged 1.61%. The 10-year yield also recovered to 2.34%. The spread between 2s and 10s is now under 73 bps and at a new expansion low (November 2007).
Tax Plan Unveiled: The House Ways and Means Committee’s tax plan was unveiled yesterday, containing positive elements for economic growth but likely proving difficult to pass. The plan slashes the top corporate rate from 35% to 20%, limits certain corporate deductions/benefits, provides for a repatriation holiday followed by a territorial tax system, reduces the number of individual brackets, sets a top individual rate of 39.6% on income over $1 million, doubles the standard deduction, increases the child tax credit, eliminates some deductible items and credits, keeps the charitable deduction, allows for retirement and college savings benefits, reduces the amount of mortgage interest allowable for deduction, and eliminates state and local tax deductibility except for up to $10k in property taxes. The corporate plan would likely lead to a boon in business investment given that it incentivizes 1) bringing foreign-domiciled monies back to the U.S and 2) investing capital given the accelerated expensing provision. This tax plan would positively affect corporations and low- to middle-income households who would benefit from the lower rates and the larger standard deduction. Higher-income households, particularly those that itemize deductions and/or live in high-tax states, would generally fare the worst under the plan. It appears inaccurate to say the plan benefits the wealthy at the expense of middle-class Americans, which should be confirmed when the plan is scored. The biggest question is if the plan can be passed through either chamber of Congress. The housing industry is lobbying against the plan saying it will cause a housing recession. Small businesses are lobbying against the plan saying it does not go far enough to help small businesses. Debt hawks will be remiss to add $1.5 trillion to the national debt. And representatives of high tax states will be hard-pressed to accept double taxation of personal income. The next few weeks should illustrate the challenges of passing this legislation more clearly.
Trump Taps Moderate Dove to Lead Central Bank: President Trump officially announced the selection of FOMC Governor Jay Powell as his replacement for Chair Yellen upon the conclusion of her term in February. He must now be confirmed by the Senate Banking Committee and the full Senate. It appears that he will be confirmed and could take the reins of the central bank by the March 21 FOMC meeting. Powell is seen as being like-minded with Chair Yellen on policy, favoring a balance sheet wind-down and slowly-rising overnight rates. However, he is more like-minded with the president’s regulatory regime. With Powell, we expect to see policy continuity during the transition from Yellen’s leadership. While Yellen’s tenure as a Governor continues through 2024, she is likely to resign upon Powell’s confirmation. This will leave three Governor seats vacant. The voting members of the FOMC will already tilt more hawkish in 2018. Given the president’s selection of Powell over Taylor or Warsh, he will likely look for more dovish members to join the Board.