Is the Trend Our Friend?

Is the Trend Our Friend?

Julia Coronado - Market Economics
US Daily Spotlight | 04 Feb 2013 00:20 |

Last week’s US data provided some big headline surprises, but, on balance, provided some key signals on the state of the US recovery. While Q4 GDP surprised sharply to the downside with a small decline, December construction data on Friday already suggested a small upward revision to a flat reading. Smoothing through the Q3 and Q4 offsetting surprises, the message seems to be the underlying run rate of the economy through 2012 was about 1.5%, somewhat below our prior estimate closer to 2.0%. While January payrolls were close to expectations, benchmark revisions going back to March 2011 suggest a higher trend pace of hiring. Nonfarm payrolls averaged 181k in 2012 and 175k in 2011. This more robust estimate of hiring coupled with a gradual, steady decline in the unemployment rate suggests trend growth in the US may be slower than most current estimates.

In a speech last November, Fed Chairman Bernanke acknowledged that “the accumulating evidence does appear consistent with the financial crisis and the associated recession having reduced the potential growth rate of our economy somewhat during the past few years”. However, his operating assumption, as reflected in the FOMC’s central tendency forecast, seems to be that we will move out of a phase of temporarily low trend growth to a more normalized economy in which we will see higher rates of growth, some people sidelined by the recession will return to work and, therefore, stronger growth will be required to achieve the kinds of declines in the unemployment rate we have seen over the past three years.

There has been some evidence in recent employment reports that this rotation to a more normalized economy and labour market is underway. While the participation rate has not staged a rebound, it held steady at 63.1% in January, and has been unchanged since April 2011. This stabilization in participation has indeed slowed progress in reducing the unemployment rate, which rose to 7.923% in January, and has declined on balance just 0.182% since April. Over this period, job growth was a little slower than the recent annual trends at 159k per month in nonfarm payrolls and 129k in the household survey. The stable participation rate reflected different trends across age groups: It edged up 0.1pp for 16- to 24-year-olds, while it edged down 0.1pp for those aged 45 to 54. Accordingly, the unemployment rate has risen 0.4pp for the younger workers to 16.8%, while the unemployment rate for the older group fell 0.3pp to 6.0% in January.

The different labour market fortunes across age groups probably lay behind the sizable drop in the median duration of unemployment to 16 weeks in January from 18 in December. The reading is the lowest since the recovery got underway, although it is still elevated by historical standards. The continued underutilization of younger workers is a worry for longer-term trends in productivity growth and, therefore, potential GDP as a generation falls short of its potential. Young people who do not have solid job prospects also will be less inclined to marry, have children and buy homes.

We get very little in the way of US data next week, but we will get our first estimate of nonfarm productivity for Q4. Given the decline in GDP and the strong pace of hiring, we expect a sizable decline. Smoothing through the volatility in the data, however, productivity growth on an annual basis has slowed to a pace around 1.0% from the peak pace in the recovery of above 4.0%. Some cyclical slowing in productivity is to be expected. However, if 1.0% represents the new trend, that combined with a projected population growth over the next 20 years of 0.5% would imply potential GDP growth of 1.5%. It will require businesses turning from their recent focus on cash cushions and share buybacks to capital investment and hiring in order to achieve something stronger.

Another key feature of the employment report to watch will be wage growth. Average hourly earnings rose 0.2% in January, down from stronger gains over the past two months, but enough to leave the annual pace steady at 2.1%. The annual pace of wage growth has stabilized in recent months after a steady, downward moderation in recent years. While we do not know where the natural rate of unemployment is, if this trend persists and even picks up, it will suggest we are closer to a new equilibrium in labour markets. Looking across sectors, the only area where a pickup in annual wage growth is evident is the construction sector, so for now it is too early to draw broad conclusions and it certainly appears that a pace of wage growth that is still near record lows points to continued labour market slack.

St. Louis Fed President James Bullard, whom we rank as the second most hawkish FOMC voter after Kansas City Fed President George, suggested in an interview on Friday that he took some signal from the stronger pace of hiring over the past three months, and that if we continue to “get some good data for a couple of months” then the Fed should consider tapering its pace of securities purchases to USD 75bn a month by the middle of the year. We think the data will indeed drive the broader consensus on the FOMC, and we think a growth pickup is not in evidence and is a tall order in light of fiscal tightening in H1. Nonetheless, the data matter and stronger numbers would have the mixed message for markets of a more self-sustaining growth outlook, but the end of Fed support.