US Economy In Better Shape Than Thought
By Tony Crescenzi
03/09/2001 03:08 PM EST
Today's employment report supports the notion that the
economy remains resilient and that it's not now in recession.
The data also suggests that the economy remains on track for
a recovery.
A 50-basis-point cut has been mildly called into question but
remains likely at the March 20 Fed Open Market Committee
meeting. But the scope for rate cuts beyond that point is
diminishing with each economic report showing the economy is
avoiding recession.
The payroll gain of 135,000 (vs. a consensus 75,000 gain) is
significant for a number of reasons. First, the gain followed an
above-trend gain of 224,000 in January, suggesting that the
January gain was not a fluke.
Second, the gain substantially reduces the likelihood that the
Fed will cut rates early.
Third, and most important, the continued gains in job growth
suggest that the economy is not in recession. In a recession,
job losses of 200,000 per month are the norm. Recent jobs
data has not even remotely approached that.
Fourth, the gain suggests that market pessimism over the
economy is excessive.
Ails of Factory Sector Havn't Spread
The details of the jobs report support the idea that the
manufacturing sector is the epicenter of current weakness in
the economy and that the inventory adjustment process is the
main source of this weakness. This is supported by the
divergence between substantial weakness in the manufacturing
sector and strength in the service sector.
Indeed, the manufacturing sector lost a whopping 94,000 jobs
after losing 96,000 jobs in January. That's the biggest
two-month job loss since February and March of 1991, in the
throes of the last recession. In contrast the service-producing
sector added 210,000 jobs in February following a gain of
154,000 in January and 102,000 in December.
This divergence strongly suggests that inventory burdens are
at the root of economic weakness. If this is indeed the case,
then a rebound in economic growth may be just around the
corner. This postulation is strengthened by the view that the
current inventory correction has already significantly advanced,
partly owing to the use of new technologies.
As Federal Reserve Chairman Alan Greenspan recently said,
"New technologies for supply-chain management and flexible
manufacturing imply that businesses can perceive imbalances
in inventories at a very early stage--virtually in real time--and
can cut production promptly in response to the developing
signs of unintended inventory building." The substantial job
losses in the manufacturing sector suggest that this is exactly
what is happening.
But the use of new technology has some upside. Here's how
Greenspan put it: "The hastening of the adjustment to
emerging imbalances is generally beneficial. It means that
those imbalances are not allowed to build until they require
very large corrections." This means that the inventory
adjustment process may come and go more quickly than in the
past. We all hope to say "Good riddance!" to that. The biggest
worry that Greenspan and others have had is that the rapidity
of the adjustment phase might feed upon itself, owing mostly to
weakened confidence levels and the synchronous response by
businesses to the economic slowdown.
But the continued strength in service sector jobs suggests that
there has been no meaningful spreading of the weakness that
has gripped the manufacturing sector. While numerous
service-sector categories have seen sharp slowdowns in job
growth they are still growing nonetheless. Since the service
sector accounts for over 80% of the U.S. economy, it's hard to
make a case for recession whilst the service sector continues
to grow.
Service-Sector Numbers
The gain in service sector jobs was seen in a number of areas:
retail +37,000; health services +28,000; financial, insurance,
and real estate +16,000 (owing partly a gain of 5,000 jobs
generated by increased mortgage refinancing activity);
business services added +24,000 as temporary help jobs (help
supply) rose for the first in five months. Weakness in the help
supply category, where jobs losses hit a record in December
has been a worry as weakness in this sector often precedes
weakness in other job categories on the premise that
businesses shed temporary jobs before they shed permanent
ones.
Importantly, the construction sector gained 16,000 jobs during
the month. While that gain is small, it followed a record gain of
158,000 the previous month. That the number did not "correct"
indicates that the gain was rooted largely in fundamental
factors, such as the buoyant housing market. Low mortgage
rates have spurred activity there.
Interestingly, the government sector added 37,000 jobs, about
27,000 more than the 12-month average. The other critical
details of the jobs report were quite interesting.
Average hourly earnings, for example, rose 0.5% in February
(consensus +0.3%) following a gain of 0.1% in January
(previously reported at unchanged). The gain put wages up
4.1% year-over-year compared to 4.0% in January. February
was the fourth straight months where the y-o-y gain was 4.0%
or higher. That's the first time that has happened since the
middle of 1998. The wage data would be a concern for the Fed
if the economy were growing strongly. The Fed has made it
clear that they are more concerned about the downside risks to
the economy than they are of inflation. But expect this concern
to resurface once the economy strengthens, especially in light
of recent inflation data showing accelerating consumer and
producer prices.
The jobless rate held steady at an as expected 4.2%. That
number is produced from a survey of about 50,000
households. The survey found that the labor force fell by
204,000 workers and that household employment fell 184,000
persons for the month. So, although there were 184k less jobs,
there were 204k less people looking for a job. This left the
unemployment rate unchanged. Economists generally believe it
will creep upward as the year progresses, but very few believe
it will top 5%. That means that while the current economic
slowdown may seem harsh, it won't be deep. In the last
recession, for example, the jobless rate peaked at 7.8%.
For the Fed, the data supports its recent theme that the
economy is basically mired in a sharp inventory correction but
that it has not slowed to the point of recession. With the effects
of the inventory adjustment process limited mostly to the
manufacturing sector, the Fed is now likely to feel more
confident in their view that the economy will strengthen in the
second half of the year. This will likely reduce its enthusiasm for
rate cuts beyond the March meeting.
Bond Market Outlook
For the bond market, while the interest rate environment is
likely to be friendly for a while, it is getting increasingly difficult
to justify further interest rate declines on the basis of a
substantially weak or recession-like economy.
Recent data simply do not fit the mold of recession: payrolls, as
mentioned, typically decline by 200,000 per month, home sales
plunge (they reached a record high in December), and car
sales nosedive (they were robust in January and February).
Other signs of improvements that I have noted recently include:
record corporate bond issuance in January and strong
issuance in February; mortgage refinancing activity is running
six times higher than the 2000 weekly average; the money
supply is surging; commercial and industrial loans are
expanding at a double-digit rate; yield spreads between US
Treasuries and riskier bonds has narrowed sharply; cyclical
stocks are outperforming most sectors and are at a one-year
high (using the Morgan Stanley cyclical index as a guide); retail
sales grew 0.7% in January; and business inventories grew at
slowest rate in two years in December, pointing to reduced
inventory burdens.
As you can see, there is a laundry list of developments that
point to an eventual recovery in the economy. Today's report
gives every reason to believe the recovery scenario remains on
track. Expect equities to outperform bonds with increasing
intensity as the year rolls on. Corporate bonds should
outperform Treasuries.
Investors should generally be heartened that economic
weakness has not spread as much as feared and that a
recession looks increasingly unlikely.
Tony Crescenzi is chief bond market strategist at Miller Tabak
& Co. and CEO of BondTalk.com. Crescenzi frequently
appears on CNBC, CNNfn, and Bloomberg TV and is often
quoted across the print and electronic media. He is a regular
participant in the Fed's Livingston Survey of economic
forecasters. |
