Today's ISM nonmanufaturing headline figure provided further evidence the US economy left 2010 on firmer footing. Generally solid internals as well, with both production and new orders posting solid gains. Like its manufacturing cousin, the weak spot was employment, a critical determinant for the evolution of Fed policy this year.
In contrast, the ADP numbers were released with great fanfare, suggesting a 297k gain in private nonfarm payrolls. A potential blowout in the making given that expectations for Friday's employment report was 140k overall. However, a word of caution regarding the ADP figure via the Wall Street Journal:
But there is a seasonal quirk in the ADP number that may have inflated the December number. ADP and Macroeconomic Advisers do a seasonal adjustment that takes into account a typical December purge, where employers who have fired workers over the course of the year but don’t remove them from officials payrolls right away clear the rolls.
Ben Herzon of Macroeconomic Advisers explains: "If companies were laying off fewer employees throughout 2010 than had been the case in recent years, the amount by which the seasonal adjustment process subtracted from [ADP National Employment Report] growth last year through November was too great. Following the same logic, fewer layoffs through November implies fewer December purges than in recent years, so the boost to December employment growth to offset the normal December purge may have been too large."
On the inflation outlook, today's ISM release revealed a higher percentage of firms reporting higher prices. Firming demand may allow firms to pass on some of these cost increases to consumers, but as the Wall Street Journal notes, this isn't a bad outcome:
If higher commodities prices do trigger a small but manageable pickup in U.S. inflation, it will count as a success for the Fed’s extraordinary efforts to avoid the ravages of deflation that have beset Japan these past two decades.
Three additional factors likely to weigh on the Fed: Housing, state and local budgets, and Europe. From the FOMC minutes:
Others pointed to downside risks to growth. One common concern was that the housing sector could weaken further in light of the considerable supply of houses either on the market or likely to come to market. Another concern was the ongoing deterioration in the fiscal position of U.S. states and localities, which could lead to sharp cuts in spending and increases in taxes. In addition, participants expressed concerns about a possible worsening of the banking and financial strains in Europe, which could spill over to U.S. financial markets and institutions, and so to the broader U.S. economy.
Despite an improving revenue picture, state and local budgets are expected to fall short of what is necessary to maintain current service levels, especially given escalating wage and benefit costs. This is likely to remain a drag on growth - and jobs - until the governments realign spending and revenue growth trends. Nothing really new here, just an ongoing concern.
And, finally, Europe. Via CR, Europe looks to be heading to renewed crisis. It would appear that despite all the EU interventions, investors believe a day of reckoning is still at hand, that at most sovereign defaults have simply been pushed out three years. I find it difficult to see how the situation is resolved without an enhanced fiscal authority in Europe with the power to make transfers, not loans, from solvent to insolvent regions, the exit of some nations from the Euro, or some combination of these two. I wish that European leaders would see the light sooner than later rather than dragging us through two or three more crises.
Bottom Line: Data continues to be supportive, with at least one more hint of solid job growth to add to the improving trend evidence in initial claims. Still, the hole we are in is deep, not every piece of data has fallen into line, the positive trends are relatively recent, and at least three swords are still holding over the heads of FOMC members. The combination should keep policymakers clinging to the current stance of monetary policy, although even the more dovish will need to publicly recognize the more solid pattern of data sooner than later.