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Weekly Economic and Financial Commentary: Labor Market Slowing but Still Strong

U.S. Review

Labor Market Slowing but Still Strong

  • Nonfarm payrolls came in well below expectations, as employers added 20K new jobs in February after adding 311K in January. The three-month average gain of 186K is still rather strong, but marks a moderation in the pace of job growth.
  • The ISM non-manufacturing survey continues to point to robust growth in the service sector, while the manufacturing sector succumbs to trade tensions and slowing global growth. The trade deficit widened to a ten-year high in December.
  • Housing starts rebounded in January, as lower rates and improved builder sentiment should provide a moderate boost to the housing market this spring.

Labor Market Slowing but Still Strong

With the Fed firmly on ‘pause’, all eyes are on incoming data for clues to its next move. Nonfarm payrolls came in well below expectations, as employers added just 20K new jobs in February after adding 311K in January. Through the volatility, the three-month average gain of 186K is still rather strong, but marks a moderation, consistent with an upward tick in jobless claims and more moderate survey evidence from purchasing managers. The unemployment rate fell to 3.8% from 4.0%. An increasingly tight labor market is finally feeding through to higher wage growth, as average hourly earnings rose 0.4%, pushing the year-over-year increase to 3.4%, the highest pace of this cycle. Yet, with the expansion pulling more into the labor force—prime age participation is up 0.4 percentage points this year—the extent of tightness, and, by extension, inflationary pressure, is perhaps overstated. That, along with a pickup in productivity growth of late, provides the Fed further reason to be patient.

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Purchasing managers’ surveys point to a growing divergence between the manufacturing and service sectors. The ISM non-manufacturing index rebounded three points this week to 59.7, and the underlying cycle highs for business activity (64.7) and new orders (65.2) point to considerable momentum. Such strength in largest sector of the economy, if realized, would likely be justification for the final Fed rate hike we expect for this cycle, in H2-2019. That assumes that the Fed’s pause allows the economy to weather ongoing ‘crosscurrents’. The ISM manufacturing survey has more clearly succumbed to a slowdown. Down to 54.2, the index has retreated from the sky-high readings of the past couple of years amidst slowing growth overseas and no definitive signs of the long-awaited trade deal with China.

Speaking of trade wars, the U.S. trade deficit widened in December to $59.8 billion, a ten-year high, as exports fell 1.9% and imports rose 2.1%. Exports to China in particular have fallen in seven consecutive months amidst retaliatory tariffs and a slowdown in the world’s second largest economy. We now expect revised Q4 GDP data to reflect a drag of 0.3 percentage points from net exports. While the cloud of trade uncertainty will likely persist for the foreseeable future, financial conditions—one of the other major crosscurrents identified by the Fed as a reason to pause on rate hikes—have eased markedly to start the year. We learned this week that household aggregate wealth fell 3.7% in the fourth quarter, with the drop owed entirely to the sharp decline in equity markets. Year to date, equity markets have retraced most of their decline, with the S&P 500 up nearly 10% as investors attempt to price in the Fed’s dovish shift.

We also suspect the pause in rate hikes came just in time to deliver a much needed reprieve to the housing market. The plunge in the NAHB homebuilders’ survey accurately predicted the string of four consecutive monthly declines in housing starts, including the 14% drop in December. Yet optimism rebounded on the Fed’s shift and the 50 bps decline in mortgage rates, and the hard data followed, with starts bouncing back 18.6% in January. Permits have risen four out of the past five months and are now running 15% ahead of starts, indicating further relief is likely ahead for housing as we enter the spring buying season with rates lower, price appreciation cooling and builder sentiment improving.

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