As the Labor Market Tightens, the Number of Jobs Created will Decline

By | July 3, 2017

Welcome to FTR’s “Monday Morning Coffee “ blog. The following article is designed to keep busy executives up to date with the latest economic data releases. Released every Monday, this blog promises to keep our clientele updated with the latest weekly economic news and developments, highlighting its impact on the transportation, freight, and equipment markets. Hopefully, this will be an informative addition to the fine body of work associated with FTR.

Overview

Coffee and Economic Review

European stocks stumbled at the end of June, as hawkish statements by central bankers boosted bond yields and the euro sparked a broad sell-off, with stocks that benefit from lower rates and export oriented companies coming under pressure. The pan-European Stoxx 600 was down more than 2% in June. Meantime, China finished the year on a strong note, with the manufacturing PMI increasing to 51.7 in June, up from 51.2 in May and the non-manufacturing index rising to 54.9, up from 54.5 a month earlier. Consumer spending slowed in the first quarter, affected by weather, but still accounted for half the GDP growth.

U.S. stocks closed up Friday buoyed by increases in the industrial and consumer discretionary sectors. Volatility is back, although by historical standards, as the debate on normalizing monetary policies is intensifying after nine years of unprecedented stimulus. This suggests that some investors are getting nervous about the economy’s ability to withstand a tightening cycle even as data showed U.S. consumers are increasing spending in line with economists’ estimates. The S&P ended up 0.2% on Friday, following a 0.9% decline on Thursday. For the quarter, the gauge ended up 2.6%.  The Dow Jones ended up 0.3% on Friday and up 3.3% for the quarter.

Last week, there seems to be a deepening tightening bias within the Federal Reserve, even as inflation remains weak. The Fed seems to be wedded to the Phillips curve, where when unemployment is high, inflation is low and the opposite theorem that is when unemployment is low, inflation is high. The Fed may also use its balance sheet to tighten market conditions, as the yields on Treasuries are expected to rise 15 to 25 basis points a year over the next few years, equivalent to an additional rate hike a year.  In other developments, the core PCE deflator increased 0.1% in May, leaving it up 0.3% annualized over the past three months, significantly weaker than the 2.5% rate in February.

The first quarter came in a stronger note, as Q1 GDP growth was revised to 1.4%, up from 1.2% in the second estimate by the Bureau of Economic Analysis. Growth in the second quarter is broadly-based, which is clear from the widespread growth in job growth.  The expansion remains remarkably stable entering the eighth year of recovery. Employment is set to tighten more and with it, higher wages will support spending. The economy is far from overheating, but pressures will be mounting in that direction in the next two years.  In the near term, we are fairly safe from recession, barring some geopolitical shock. However, downside probabilities to rise in the next two years as interest rates continue to increase.

This week will be a busy one for economic data. Construction spending and the manufacturing and non-manufacturing indexes of the ISM are released. Manufacturing should see a slight gain, but the non-manufacturing sector likely lost some ground. Vehicle sales probably lost some ground. The trade deficit likely narrowed in May. The Fed will release minutes from the June FMOC meeting that will fill in some data about the coming reduction of the balance sheet. Employment growth finishes out the week, with an estimated 160,000 jobs. As the labor market tightens, the number of jobs created will decline, but anything north of 100,000 per month is all that is needed to keep up with the growth in working-age population.

Latest Data

The U.S. Economy:

The pace of U.S. growth slowed in May. The Chicago Fed National Activity Index dropped to -0.26 in May from 0.57 in April because of loses in the production-related indicators. Three out of four subcomponents that make up the index declined in May from the previous month. The production of production-related indicators plummeted to -0.16 from 0.53 previously. Employment-related indicators contributed -0.2 in May, compared with 0.12 in April. The 3-month moving average dipped to 0.04 from 0.21 in April. Although the index dipped in May, it is too early to sound an alarm. The 3-month moving average remains in expansionary territory and has been positive for five out the last six months. The biggest losses for the index were production variables, which are the most volatile. Although industrial production was unchanged in May, the manufacturing sector is clearly doing better than a year ago.  However, that doesn’t erase all concerns. With housing starts flat, auto sales are topped out and low oil prices; there are some worries about future production. Employment growth remains positive, but wage growth is still stuck in low gears. The economy will remain positive, but there are some questions about the strength of the recovery.

New orders for durable goods disappointed in May, falling 1.1%, the second consecutive decline. The decline was mainly driven by the civilian aircraft sector, but there was weakness elsewhere. Core capital goods orders fell 0.2%, but April was revised upwards from 0.1% to 0.2%. Excluding transportation, orders rose 0.1%. Among manufacturing industries, data was mixed. Orders for electrical equipment gained 1%, but orders for computer and other electronic products fell 0.2%.  Primary metals advanced 0.3% m/m and are up 12.5% from a year earlier. New orders lost ground in April and took a step back in May. Businesses remain upbeat by historical standards, but the robust sentiment following the presidential election has softened. As a result, the improvement in manufacturing looks less impressive than earlier this year. Manufacturing added 11,000 jobs in April, but lost 1.000 in May. Businesses are waiting, hoping for infrastructure stimulus and tax reform, but is unlikely to happen before next year, if at all. That raises the probability that businesses may pull back because of policy uncertainty. Still, the domestic economy is still solid and the global economy is advancing.

The advance goods deficit suggests that exports were not overly supportive of growth midway through the second quarter. The goods deficit narrowed from a revised $67.1 billion in April to $65.9 billion in May. Nominal exports rose 0.4%, while imports fell 0.4%. On a year-ago basis, nominal exports were up 6.4% and nominal imports were up 7.1%. There should be some improvement in months ahead, as the global economy is gaining a little acceleration and the value of the dollar has moderated, which should boost exports. There are risks to trade with talk of tariffs, a border tax adjustment and renegotiation of trade deals. Trade deals are unfavorable for autos, with the consumer showing signs of fatigue, but that won’t hurt the expansion in a meaningful way.

The pending home sales index fell 0.8% in May to 108.5. The index is now 1.7% higher than its year earlier reading, but still below its cyclical high in mid-2016. Pending home sales hit a temporary lull over the past few months, portending near-term weakness in existing home sales. However, despite the recent weakness, sales remain within striking distance of their cyclical high. Mortgage applications, a leading indicator of sales, have been trending higher over the last year and are near their highest level since early 2010. Supply-side restraints remain a problem for the industry. A lack of inventory is hurting pending home sales. Labor restraints are also hurting the construction industry. However, fundamental housing demand drivers are moving in the right direction and will support future home sales.

Personal income rose 0.4% in May, up from a 0.3% advance in April.  Personal spending rose just 0.1% in May, following a 0.2% increase in April. Spending growth has stabilized after weather-related volatility over the winter. Prospects for spending in the medium term are bright, as personal income is set to increase at stronger rates, as the impact of a full-employment economy seeps through the economy. Consumers are benefitting from low energy prices, but service sector inflation is increasing. There are risks to the outlook. The Trump administration wants tax cuts and greater government spending, but Congress appears unable to pass legislation. Interest rates are likely to continue to keep rising, with a danger of overshooting the mark. The PCE deflator fell 0.1% in May, after a 0.2% advance in April. The PCE deflator is up 1.4% year-over-year.  Inflation is weak, but the Federal Reserve believes it will get stronger in coming months.

International:

German business confidence logged its fifth consecutive monthly increase, underpinning optimism that Europe’s largest economy will continue to grow.  Growth was the fastest in a year in the first quarter, supported by a pickup in manufacturing, which bodes well for investment. The Munich-based Ifo Institute’s business climate index rose to 115.1 in June, up from 114.6 in May.  That’s the highest since reunified Germany data was available. As the domestic economy gains more momentum, the biggest risk for Germany comes from overseas. So far business managers have ignored the specter of protectionist policies from the U.S. and the threat of weaker growth in the U.K. in response to Brexit talks. The latest German PMI was at the highest level since 2001.

The Chinese official factory gauge ended the first half of the year on a healthy note. The manufacturing PMI rose from 51.2 in May to 51.7. The non-manufacturing index rose from 54.5 to 54.9.  New export orders rose to 52.0, the highest since April 2012. Economic growth this year has been more resilient than expected, giving policy makers time to focus on reining in financial risks cooling a frothy property sector. Firmer global trade is boosting corporate profits and easing fears that efforts to cut excessive borrowing would reduce output below targets. Recent data suggests that momentum will be healthy and that China will only see a modest slowdown in coming quarters.

Important Data Releases This Week

June ISM manufacturing index will be released on Monday July 3 at 10:00 AM EST. We expect that manufacturing will increase from 54.9 in May to 55.7. Manufacturing has cooled a little from the first quarter average of 57, but we expect some improvement as the regional surveys were up.

May construction spending will be released on Monday July 3 at 10:00 AM EST. Construction spending should resume its positive trend, rising 0.2% in May after a 1.4% decline in April. Public spending remains positive for most of the year but is moving upwards at a slow pace.

June vehicle sales will be released on Monday, July 3 at 4:00 PM EST. We expect sales to decrease from 16.66 million in May to 16.56 million in June. Sales have peaked for the cycle but will average roughly 16.5 million for the remainder of the year.

May factory orders will be released on Wednesday, July 5 at 10:00 AM EST. We look for factory orders to fall 0.2%. The capital goods orders fell 0.2% in the advanced release of durable goods and total durable goods orders fell 1.1%.  Aircraft orders were weak in May, but other non-transportation sectors seem to be holding up. Orders, excluding transportation, rose 0.1%.

May international trade will be released on Thursday, July 6 at 8:30 AM EDT. We project the trade deficit to narrow from $47.6 billion in April to $45.9 billion in May. Already released goods data showed imports declining 0.4% and exports rose 0.4% during the month. A slightly weaker dollar should help exports.

June ISM non-manufacturing index will be released on Thursday, July 6 at 10:00 AM EST. Service sentiment has softened lately as expectations of stimulus have diminished. This suggests some backtrack in the ISM non-manufacturing index from 56.9 to 56.9 in June. This still a decent reading and consumer fundamentals are still solid, but the index is likely to backtrack a little.

April employment will be released on Friday, June 2 at 8:30 AM EDT. We look for employment to rise by 160,000, close to the average over the last six months. The unemployment rate will rise to 4.4%.


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About Steve Graham

Steve is one of the premier analysts in the transportation equipment industry. On a monthly basis Steve tracks and analyzes in detail the trailer and heavy-duty truck industry. Aside from following these two sectors he is also instrumental in helping our customers analyze the economy and its impact on transportation and transportation equipment.

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