The Economy
Lots Of Noise, Little In The Way Of Change
June 2024
One of the best pieces of investment advice we’ve ever come across is "don’t make short-term judgments about long-term assets." If there were a corollary to apply to our task of economic analysis and forecasting, it would be along the lines of "don’t make long-term judgments about short-term moves in the data." To be sure, giving advice is often much easier than following advice, but it is nonetheless striking to us how so many analysts and market participants seem inclined to treat each and every new data point as a stand-alone statement of underlying economic conditions. Even worse, it seems that of late the reaction to each new data point is couched in terms of whether that data point makes it more/less likely the FOMC will cut the Fed funds rate sooner/later. One can make a case that enough market participants viewing each and every data release through this narrow prism has been a prime factor behind what has been considerable volatility in equity prices and yields on fixed-income securities while doing nothing to advance anyone's understanding of the state of the U.S. economy.
Those who have followed us for any length of time know that our reactions to the economic data releases tend to be considerably more tempered. After all, the narrative of an economy as large as the U.S. economy doesn't change from one month to the next, let alone from one data release to the next, the obvious exception being the onset of a global pandemic. Recall that the general theme of our commentary in last month's edition was "appearances can be, and often are, deceiving." We noted that much of the data for the month of April suggested a marked slowdown in the pace of economic activity, and while we did indeed think the economy to be slowing, we thought the April economic data were overstating the degree to which that was the case. That included an April employment report which showed a significant slowdown in job and wage growth, and the ISM’s surveys of the manufacturing and services sectors, both of which were shown to have slipped into contraction in April. To our earlier point, the reaction to seemingly soft economic data for the month of April was along the lines of "bad news is good news," in that the April economic data were generally seen as making Fed funds rate cuts more likely.
As for us, in keeping with one of our fundamental tenets – for any given data release, the headline number is the least important number as the real story is told by the details – we decided to let the details of the data releases do the talking. As we discussed last month, the details of the April data led us to conclude that the economy was not slowing to the extent implied by many of the headline numbers, with measurement/collection issues and punitive seasonal adjustment the source of much of what we saw as false signals. The one thing we could be sure of was that it wouldn't take long for us to know whether our assessment was on base or off the mark, with the May economic data delivering the verdict.
After having slipped to 49.4 percent in April, the ISM Non-Manufacturing Index bounced back to 53.8 percent in May. While any reading below 50.0 percent indicates contraction, it was hard to make a plausible case that the broad services sector actually fell into contraction in April, particularly with continued growth in new orders. The ISM’s May survey put that notion to rest, showing a significant increase in business activity and a seventeenth straight month of orders growth. Still, the ISM Manufacturing Index remained below 50.0 percent in May while new orders fell for a second straight month, but at the same time the survey results indicated growth in employment and output while comments from survey respondents were split between those indicating growth and those indicating softening demand.
This is a useful reminder that, at any given time, not all industry groups within a broad sector, whether manufacturing or services, are moving in the same direction or at the same speed. Our sense is that the ISM Manufacturing Index will not stray too far in either direction from the 50.0 percent break between contraction or expansion over coming months. One thing the ISM's May surveys had in common was that upward pressures on prices for non-labor inputs have yet to abate in either the manufacturing or services sectors, which is at odds with the premise of meaningful and sustained weakening in demand.
In last month's edition, we noted that the April employment report was warmly embraced by market participants, as the appearance of softening labor market conditions inspired hope that the FOMC would be free to start cutting the Fed funds sooner rather than later. We noted that the operative word was "appearance," as we argued the April employment report painted a misleadingly soft picture of labor market conditions. In contrast to many who instead saw the April report as a turning point, we expected payback in the May employment report, which proved to be the case. Total nonfarm employment rose by 272,000 jobs in May, trouncing the consensus forecast of an increase of 180,000 jobs, while average hourly earnings rose by 0.4 percent, leaving them up 4.1 percent year-on-year, up from April's pace. Despite an increase in the unemployment rate, to 4.0 percent from 3.9 percent in April, the May employment report was given the cold shoulder by market participants, many of whom saw the robust job and wage growth a pushing the initial cut in the Fed funds rate further out into the future.
As was the case with the April employment report, our reaction to the May report was a bit different than that of market participants. As noted above, we expected payback in the May report, hence our forecast of an increase of 258,000 jobs. That said, just as we did not think the labor market had softened to nearly the degree implied by the April report, neither do we think the labor market to be as robust as implied by the May job and wage growth prints. Our view is that the seeming strength in the May data is a direct result of the seeming softness in the April data, with reality somewhere in between.
When viewed in concert, the past two employment reports are right in line with other indicators showing cooling labor market conditions. The trend rate of job growth is slowing, as is the trend rate of wage growth. We know from the Job Openings and Labor Turnover Survey (JOLTS) that job vacancies are falling rapidly and the rate at which firms are hiring workers has slipped below the pre-pandemic rate, as has the rate at which workers are voluntarily leaving jobs. Still, it is worth noting that the level of job vacancies remains well above pre-pandemic norms while the rate at which firms are laying off workers remains below pre-pandemic norms. In short, nothing has changed our assessment that, while cooling, the labor market is nowhere near on the verge of collapse.
Despite the considerable swings in the tone of the economic data over the past two months, our view of the underlying state of the U.S. economy is little changed, as can be seen in the comparison of our May and June baseline forecasts. The notable exception is the change in our take on Q2 real GDP growth, but that is mainly a reflection of the revised Q1 GDP data released between our forecast runs. We do think the economy is slowing, but we’ve expected that for some time, and we think inflation remains persistent enough to leave the FOMC on hold until at least September, if not longer. Sure, we get that markets are gonna do what markets are gonna do, and seeing considerable volatility in asset prices can lead one to feel they should be doing something, just as forecasters can be tempted to change their forecasts when so many others are doing the same. Sometimes, though, the best thing to do is nothing at all.
Sources: Bureau of Economic Analysis; Bureau of Labor Statistics; Institute for Supply Management
As of June 13, 2024
