IN THIS ISSUE:
1. Stronger Than Expected February Jobs Report
2. Will Strong Jobs Report Hasten the Fed Liftoff?
3. Where Interest Rates Are Headed: Fed vs. Futures
4. Consumer Spending Falls Two Months in a Row
5. 4Q Worker Productivity Fell More Than Expected
6. Webinar With Niemann Capital Management Now Online
Last Friday’s unemployment report for February was stronger than expected, both in terms of new jobs created and the headline unemployment rate which fell from 5.7% to 5.5%. This sparked growing fears among investors that the Fed will move to raise short-term interest rates sooner rather than later. Stocks fell sharply just after the report.
The debate over when the Fed will raise interest rates this year, by how much and over what period of time, continues. The financial media hangs on the Fed’s every statement, looking for clues as to whether the first rate hike will happen in June or September or even later this year.
Whenever “liftoff” happens, it is likely to be only a quarter-point hike in the Fed Funds rate – the interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight – which is currently around 0.1%.
How much the Fed Funds rate could rise over the next few years is a subject of much controversy – as I discussed in my blog last Thursday (you really should subscribe) – but most analysts don’t expect the key rate to rise above 1% by the end of this year.
Today we will discuss when the Fed might make its first move and how much rates may rise over the next several years. But before we jump into that discussion, let’s take a look at last Friday’s unemployment report, which saw the headline unemployment rate drop to 5.5%, the lowest in seven years. However, as is often the case, not all the data in the latest jobs report were positive. I’ll explain the good and the bad as we go along today.
Stronger Than Expected February Jobs Report
US employers reportedly added 295,000 jobs in February, according to the latest payroll report from the Bureau of Labor Statistics (BLS) on Friday morning. That was considerably stronger than the pre-report consensus of 240,000 new jobs. Over the last six months, new jobs have averaged 263,000/mo.
The headline unemployment rate, which is drawn from a different survey of households, also came in better than expected, moving down to 5.5% from 5.7% in January. This is the lowest rate since May 2008.
Measures of unemployment that include discouraged workers and marginally attached workers also declined. This broadest measure of underemployment, which also includes part-time workers who would like full-time work, declined to 11.0%, from 11.3% in January.
As is often the case, not all of the news in Friday’s jobs report was good. In February average hourly earnings increased by only 3 cents to $24.78. This followed a 12 cent increase in January, the biggest monthly raise since November 2008. But with February’s slowdown, the 12-month wage growth rate ticked down to 2%. Pre-crisis annual wage growth was north of 3%.
The labor force participation rate fell slightly from 62.9% to 62.8%. It has hovered below 63% for 11 straight months and remains near its lowest point since 1978. Currently, there are 92.9 million Americans out of the labor force. Combine that with the 8.7 million Americans who are unemployed, and there are over 100 million Americans on the sidelines of our economy.
While the unemployment rate continues to drop, long-term unemployment remains stubbornly high. The number of people unemployed for 27 weeks or longer was 2.7 million in February compared to 2.8 million in January. Long-term unemployment has yet to come anywhere near pre-recession levels and remains as high as it was during the depths of the 1980-82 recession.
Finally as noted above, Friday’s unemployment report cited 295,000 new jobs created last month, which was much higher than expected. However, this number comes from the BLS’ “Establishment Survey,” which includes a lot of jobs that are assumed into existence via the BLS’ “Birth/Death Model.” The BLS’ “Household Survey” numbers did not support the notion that happy days are here again.
According to the BLS Household Survey,” total employment increased by only 96,000 new jobs during February. The rest of the reduction in unemployment last month was the result of 178,000 working-age people dropping out of the labor force. This is what caused the labor force participation rate to move back down to 62.83%, which was the level of June 2014, and only slightly above that of November 1977.
As has been the case throughout the current economic recovery, the reported drop in the unemployment rate (from 5.7% to 5.5%) was almost entirely due to people dropping out of the workforce. So while last Friday’s unemployment report was better than expected on the surface, and a good sign for the economy, serious structural problems still exist. With more Americans dropping out of the labor force and the anemic growth in wages, we still have a long way to go.
Will Strong Jobs Report Hasten the Fed Liftoff?
Despite the better-than-expected unemployment report last Friday, the major stock indexes closed sharply lower on that day with the Dow and the S&P 500 losing apprx. 1.5%. After seeing the strong jobs report, investors immediately worried that the Fed might move up its timetable to begin raising short-term interest rates.
The jobs report also sent turbulence into the bond markets, with the US 10-year Treasury note yield rising sharply to 2.25% and the 2-year surging to 0.73% on increased anticipation of an interest rate hike. The US dollar also soared to an 11-year high against the euro on fears of an earlier rate hike.
Going back to former Fed Chairman Bernanke’s final term, the Fed has maintained that it would consider the economy to be at “full employment” when the unemployment rate fell to between 5.5% and 5.2%.With Friday’s report showing the jobless rate at 5.5%, many investors now assume that the Fed would make the first rate hike in June, rather than September.
The next policy meeting of the Fed Open Market Committee (FOMC) is set for next Tuesday and Wednesday, March 17-18, with a press conference to follow with Chair Yellen. You may recall that Yellen and recent policy statements have said that the Fed can “be patient” when it comes to the initial interest rate hike.
The thinking now is that the Fed will remove ‘patient’ from the policy statement that will be released following next week’s meeting. I don’t know if that will happen or not, but you can bet the markets will be very sensitive if it is removed.
Yet it may be that investors’ concerns about a rate hike in June are premature. In her recent testimony before the Senate Banking Committee in late February, Yellen cautioned that while the labor market has seen improvement, “too many Americans remain unemployed or underemployed, wage growth is still sluggish and inflation remains well below our longer-run objective.”
Mrs. Yellen also told lawmakers that the central bank’s policy-setting committee “needs to be reasonably confident that over the medium-term inflation will move up toward its 2% objective before it starts to raise interest rates.”
That didn’t exactly sound like someone who is in a rush to raise rates. Hopefully, we’ll find out more on March 18, when Fed officials release updated economic projections – including new estimates for the long-run unemployment rate target range.
Where Interest Rates Are Headed: Fed vs. Futures
The FOMC has specific targets for where it wants the Fed Funds rate to go between now and the end of 2017. However, the Fed Funds futures markets have a very different set of targets over the same period of time. I wrote about this at length in my blog last Thursday.
The Fed Funds futures are predicting substantially lower rates than the Fed’s official targets. Take a look at the chart below.
Clearly, either the Fed is correct or the markets are correct. As a futures guy for the last 38 years, I would not bet against the markets! That is not to say that the rates implied by the futures markets won’t rise (or fall) in the months and years ahead – that will depend on how the economy responds to the first few rate hikes.
To read my full analysis, click here. This is another reason to subscribe to my free weekly blog if you have not already.
Consumer Spending Falls Two Months in a Row
US consumer spending fell for a second straight month in January as households continued to cut back on purchases, opting to save much of the massive windfall from cheaper gasoline.
Consumer spending, which accounts for more than two-thirds of US economic activity, slipped 0.2% after falling 0.3% in December. The January dip reflected lower gasoline prices, which weighed on sales receipts at service stations, as well as the drop in purchases of big-ticket items.
Housing data for January released last month was also weak. That and another report from the Commerce Department showing a 1.1% drop in construction spending in January prompted some economists to cut their first-quarter growth estimates.
Morgan Stanley cut its 1Q growth estimate from 2.8% to 2.3% (annual rate), while forecasting firm Macroeconomic Advisers lowered their forecast to 2.1% from 2.3%. Other forecasting groups will likely trim their estimates of 2015 economic growth in the weeks just ahead.
The back-to-back monthly declines in consumer spending growth underscore the likelihood that 2015 GDP growth will again fall short of 3% where it has been for more than a decade. This can change, of course, and I will keep you posted, as always.
4Q Worker Productivity Fell More Than Expected
In my blog on February 26, I made the case that the shrinking middle class in America is not primarily due to “income inequality” as President Obama repeatedly claims. Rather, I argued that falling growth in worker productivity is the main catalyst for the shrinking middle class.
The data I used came straight from the president’s own White House Council of Economic Advisers, so Mr. Obama has to know that his income inequality argument is mostly bogus. But I’ll leave that discussion for another time.
In that blog, I reported that the Labor Department estimated in February that US worker productivity declined 1.8% in the 4Q of last year. Last week, the Labor Department revised that number down to -2.2%(annual rate) for the 4Q. For all of 2014, worker productivity grew by only 0.7% as compared to 0.9% in 2013.
2014 marked the fourth consecutive year in which productivity growth has been well below the long-term average of 2.5%. Since 2011 productivity growth has averaged only 1.0%. Most analysts agree that this significant slowdown is due in large part to the explosion in federal regulations in the last decade. The National Association of Manufacturers estimates that federal regulations cost the economy a whopping $2 trillion annually.
For the first time in post-World War II history, more US businesses are shutting down as compared to new startups. Would-be entrepreneurs are less likely to risk their limited capital on new ventures given the daunting regulatory maze and the anti-business policies of the current administration.
The real point is that rising income inequality is not the main driver that is shrinking the middle-class. Rather, the biggest threat to the middle class is the big decline in worker productivity growth since 2007.
Very best regards,
Gary D. Halbert