Economists have been tearing their hair out trying to deconstruct the recent string of negative data surprises, which have undermined confidence in growth, to eliminate the weather effect. The first significant tainted release in this series was probably the ostensibly weak employment report for December, which we received on 10 January. The consensus had been for a 197,000 increase in non-farm payrolls, but the data showed only 74,000. Weekly earnings and hours worked also ticked down and failed to match expectations, and the headline unemployment rate apparently only fell due to a further fall in the participation rate to a new low for the cycle of 62.8.
Further disappointments followed for building permits and pending home sales, the Manufacturing ISM survey, and vehicle sales. Finally the icing on the cake was the January employment report, released on 7 February. As in the previous month, non-farm payroll growth disappointed, at 113,000, as against a consensus for 180,000. However, perhaps we have seen the first signs of Spring, as the household survey revealed a contrasting picture, with a 638,000 increase in employment, an increase in hourly earnings, a fall in the broader, U6, measure of unemployment to 12.7 per cent (the lowest since the Fall of 2008, just after the Lehman bankruptcy, when U6 was sky-rocketing). Last but not least, the participation rate ticked up to 63.0 per cent.
All of the above conspired to force the yield on 10-year US T-Notes down from just over 3.0 per cent at the turn of the year, to a low of 2.58 per cent on 3 February, as investors dashed for cover.
As we stand, the new Fed Chair Janet Yellen has made it clear that continuity will be the watch-word, and that she feels the output gap is still considerable, implying a huge swathe of avoidable and unnecessary human misery. In support of this view, she would point to the employment-to-population ratio, which has improved negligibly since the recession, when it fell through the floor, as a good indicator of huge slack in the labour market. However, New York Fed researchers Samuel Kapon and Joseph Tracy recently published a paper highlighting the potential for the employment-to-population ratio to mislead us, unless we take account of “baby-boomer” demographics:
The E/P ratio is a misleading indicator for the degree of the labor market recovery. Adjusting for changing demographics has an important impact on the picture that emerges about the degree of the labor market recovery. The actual E/P ratio suggests that the labor market has made relatively no progress since the end of the recession in recovering from the 4.1 percentage point decline in this measure. In contrast, the gap between the demographically adjusted E/P ratio using our normalization and the actual E/P ratio is a much smaller 0.7 percentage points.
In other words, permanent drop-outs from the labour force (retirees, for example) of course mean that the participation rate has fallen and therefore the fall in headline unemployment rates is “for real” and has the potential to lead to an inflation problem quite quickly. The last Fed meeting minutes highlighted that, “much of the downward trend in the labour force participation rate since the start of the recession … as the result of shifts in the demographic composition of the workforce and the retirement of older workers.”
The US economy also faces much less fiscal drag this year, with the expected change in cyclically adjusted budget balance being +0.5 per cent in 2014, after +2.7 per cent last year.
Turning to the markets, they already seem to be correcting for the weather effect. Treasury yields actually rose last week, even in the face of several weak-ish data releases. Fed fund futures are still priced well to the dovish side of the FOMC’s December Summary of Economic Projections (SEP), and don’t forget the FOMC’s membership changed in January, becoming significantly more hawkish. Taking all of this into account, although the current storms may well weigh upon February’s statistics, Q2 growth could now hit 4 per cent and US rates could move significantly higher along the curve. Of course this may have dramatic effects upon the equity markets and on EM currencies.