Economic Notes – June 9, 2014


Written by: Jon McGraw

  • Featured by an unusual correction in the manufacturing ISM, economic data for the week was decent. The more dramatic news came from Europe, where the ECB provided additional easing and elected a new ‘negative interest rate’ policy, the first of its kind for a major central bank.
  • Equity markets generally rose across the board on positive economic data in the U.S. and ECB easing; this was coincident with higher U.S. interest rates.

(0) The May ISM manufacturing survey experienced an oddity, as the initial release was fraught with errors and had to be revised twice in subsequent hours—causing markets to change course. It initially came in weaker than expected, falling a few points, but after the series of corrections, the final figure was updated to 55.4. As an increase from April’s 54.9 to 55.5 was initially forecast, this final figure was largely unexciting but an improvement on the prior month all the same as the diffusion methodology implies. The details were largely in line with the headline, as production and new orders rose, employment fell, and inventories were unchanged from April. Some of the anecdotal commentary from survey respondents came back positive, as stronger demand was noted.

(+) The ISM non-manufacturing index came in a bit stronger than expected for May, and in less dramatic fashion than the multi-revised manufacturing index, rising from April’s 55.2 up to 56.3 (beating the forecasted 55.5). It’s now back at the highest level since last summer, as the components of business activity, new orders and employment all gained, while inventories were flat.

(-) Construction spending in April rose +0.2%, but underwhelmed forecasts calling for a +0.6% gain. On the positive side, upward revisions to March and February offset some of this disappointment. Private residential spending rose by just a few ticks, partially due to a -2% drop in home improvement spending, while non-residential edged down slightly. The largest component of the latter was a -12% drop in communications structures (cell towers, phone lines, fiber optic, etc.) Public spending gained almost a percent.

(+) Factory orders for both durable and non-durable manufacture goods in April came in stronger than expected, gaining +0.7% compared to a consensus +0.5%. Additionally, March orders were revised up almost a half-percent. Manufacturing inventories also rose +0.4% in April, which is a positive for the economic growth side and GDP calcs.

(+) Auto sales in May were strong, with a seasonally-adjusted selling rate of 16.8 mil. units, up 9% from last year’s levels. In fact, the best May in nine years. The Japanese brands tended to see slightly larger increases than domestic, but most all were in the double-digits; Ford lagged, only up a few percent, due to planned decreased incentives in certain truck models for inventory control. The average new car price has risen to $32,300, up 2% from last year (per Kelley Blue Book). No doubt some of this may be pent-up demand from winter, where buying was postponed, but we’ll have to see how ongoing months report.

(0) Unit labor costs in the first quarter rose +5.7%, outperforming consensus calls for a +5.3% gain. The full year increase was +1.2%. Nonfarm productivity for the quarter was initially quoted as falling -1.7% but was revised to a weaker -3.2%, which was just a bit lower than expectations of -3.0%. The perhaps most-watched component, hourly compensation, gained +2.3% in the quarter.

(-) The April trade balance of exports minus imports widened sharply, from -$44.2 billion in March to -$47.2 bil. in April (compared to expectations of a narrowing to -$40.8 bil.). It was non-petroleum related, as imports gained a percent relative to exports, which fell slightly. From a high-level standpoint, it appears some import buying may be due to pent-up winter demand (the consumer spending part is a good thing; just a lot of that benefit is going to non-U.S. firms, such as cars and phones), while exports are down a bit with weakness in Europe and some emerging markets.

(-) The ADP employment report for May was less impressive than anticipated, showing a gain of +179k jobs compared to an expected +210k. Gains were largest in professional/business services (+46k) and trade/transport/utilities (+35k), while construction and manufacturing also gained +10-15k. While of some use in the measure of private employment, the correlation to the Friday government payroll report is still not as great as some economists would prefer.

(-) Initial jobless claims for the May 31 ending week moved up a bit from 304k to 312k, just above expectations of 310k. Continuing claims for the May 24 week came in lower to a new post-recession low point of 2,603k, better than the 2,625k expected. There were no special factors noted to skew the data.

(0) The government employment situation report for May was generally in line with expectations. Nonfarm payrolls rose +217k, +2k better than forecast, and was the 4th straight month of over +200k gains. In terms of leading segments, healthcare and private education jobs rose +63k, professional/business services gained +55k and leisure/hospitality rose +39k. Interestingly, payroll employment has just passed its peak in 2008, although the pool of working-age folks has risen. The unemployment rate was unchanged from last month at 6.3%, despite expectations for a small tenth of a tick up. The U-6 ‘underemployed’ measure fell a tenth to 12.2%. The closely-watched labor force participation rate remained steady at 62.8%. The household employment portion of this (as distinct from nonfarm payrolls and includes a broader measure of the self-employed and farm/agricultural work) rose +145k. However, adjustments made to make both surveys more consistent brought this to an equivalent of +559k—which is considered quite strong. Average hourly earnings rose +0.2% in May, which was on par with expectations, and up +2.1% on a year-over-year basis. Average weekly hours were unchanged at 34.5.

(+) The Fed Beige book of anecdotal comments from the various Fed branches reported continued modest to moderate expansion across the 12 districts. Nationwide, there appeared to be stronger consumer spending activity (notably in auto sales and tourism), as the cloudy skies of winter weather have cleared a bit (quite literally). Manufacturing growth has also improved, in areas such as autos, aerospace and metals; housing commentary was mixed, as robustness in construction and sales activity in larger markets was tempered by constrained conditions in other areas. Employment growth was listed as ‘steady to stronger’ in the majority of regions, although, interestingly, a shortage of skilled workers was mentioned. Anecdotally, inflationary forces from wages and prices remain tempered, which is in keeping with formal data showing it at a measured pace.

(0) We discussed the possibility of the ECB lowering some rates into the negative last week, and they certainly did it. Aside from dropping benchmark rates from 0.25% to 0.15%, they became the first major central bank to basically charge banks for parking money (we discussed the rationale for this choice last week—the answer is hope for a creation of more private sector credit). In addition, they’ll offer cheap funding to Eurozone banks (for short terms, and again under the conditions that these funds be used for loans). They would also like to do more of the QE the Fed used so extensively here, but the asset-backed markets across the pond aren’t as deep as ours are, so you wouldn’t see the same impact from purchases. You see the theme here of what they’re trying to accomplish—getting liquidity into the system. Inflation in the zone has fallen from an annualized rate of 2.5% in 2012 to around 0.5% today. While they’re not upset about the absolute number (Europeans tend to be more inflation-phobic than Americans for historical reasons), the implication that economic growth is not high enough to spit out a small byproduct of inflation is troubling to policymakers. Conditions have improved in some areas, but they do remain in a deep trough, hence the additional action. These actions take time to gel, so it may be several quarter before the results are known.

Market Notes

Stocks experienced a bullish week and new S&P 500 highs due to better economic data, positive payrolls and the ECB easing all noted above. Domestically, industrials and financials led from a sector standpoint, while telecom lagged as the only negative performing area. Higher-beta small-caps beat large-caps, in keeping with the stronger sentiment. That pulled small-caps out of their negative year-to-date position.

Outside the U.S., Europe and Japan were up roughly 2%, while the U.K. trailed with gains of just above a half-percent. The ECB decision obviously played a role, as leading nations were some of those on the periphery. A weakening of German inflation by a half-percent to under 1% buoyed hopes for ECB action, which happened by later in the week. Stocks rallied in response. Emerging markets fared even better, led by continued recovery gains in India on governmental optimism, as well as Thailand and Russia, with lessened concerns. Australia and New Zealand were the laggards, as higher capital requirements for banks in the former caused some concern.

U.S. bond prices were down sharply on the week, as flows moved back towards equities—pushing the 10-Year Treasury back above 2.5%. Long-term investment grade bonds lost the most ground, while high yield gained on tightened spreads. Contrary to the U.S., European bonds rose on the ECB announcement, as rates lowered, as did emerging market debt.

Real estate gained across the board, on par or better than global equities—led by European REITs, per the ECB action, as well as U.S. industrial/office and retail, as better economic data would tend to boost prospects.

Commodities were flat on average last week. Natural gas earned gains in the +5% range as lower storage in the U.S. raised concerns over supply should summer heat up. Coffee and cotton corrected in a continuation of a recent trend (in coffee, perhaps an overbought condition). Copper lost several percent and was in the global news as Chinese investigators were reviewing potentially fraudulent warehouse receipts, for which the metal is often used as collateral.

Have a great week!