Tim Duy with his latest Fed Watch:
Like a Broken Record, by Tim Duy: The minutes of the last Fed meeting need to be taken in context of the data that has been released since then. And, on net, that data is coming in strong enough to keep those more dovish members of the FOMC on the sidelines. I continue to anticipate that the Fed will maintain rates steady for at least the first half of the year, and that they will maintain their inflationary bias for longer than many expect.
The employment report is a good place to start. Aside from the expected weakness in residential construction and manufacturing, it is hard to find much to dislike about the December numbers. Job gains were well spread through the economy, with a particularly solid 50k in professional and business services. Within that, the temporary help category has gained 15k, bringing stability to an indicator that was looking somewhat worrisome. (Locally, the temp help firms insist there are no workers left to hire. I tell them they need to raise their wages. It’s a game we play). Pay was up, aggregate hours were up. And, from the household survey, the unemployment rate held constant even as labor force participation gained. The icing on the cake was an upward revision of the previous two months.
I feel I need to say something about one of my pet peeves, the ADP report. I do not pay special attention to the ADP report. I simply don’t trust that it provides any useful information above that offered by a host of Wall Street economists. Moreover, when it misses, it misses big. I was somewhat amused by Macroeconomic Advisor’s Joel Prakken’s defense of the number in the WSJ Marketbeat blog:
He [Prakken] also noted that ADP got the direction of some sectors right – drops in manufacturing and construction.
Please tell me who didn’t expect a drop in construction and manufacturing employment? I will make two “bold” predictions now, without the benefit of the vast ADP resources. Residential construction payrolls will continue to contract until building starts stop falling (Calculated Risk reminds us of this frequently, for free even). And manufacturing payrolls, at least in relative terms, and likely in absolute terms, will continue to decline throughout my lifespan. Worse, Prakken adopts the increasingly used “The government data is wrong when it doesn’t fit my view” defense:
And he [Prakken] held out hope that ADP might end up being right in the end. The government goes back and revises its numbers as more businesses respond to its monthly surveys. In the end, he noted, the government numbers might be revised down and come closer to ADP’s estimate of a drop in payrolls for the month.
How much closer? Jim Hamilton makes an estimate and puts some perspective on the implications:
Applying that same approach [weighted average] to this month's ADP, NFP, and household numbers gives an estimate for December employment growth of 160,000-- given how bearish the ADP numbers were, the initial NFP estimate is likely too optimistic. However, the number could be revised quite a bit below 167,000 and still be better than many of us were expecting.
Truth be told, I feel quite a bit of sympathy for Prakken and his colleagues at Macroeconomic Advisors. They are creating simply another estimate of the nonfarm payrolls figure, the same as all the economists who form the “consensus.” They, however, are forced to defend their estimate more because ADP markets it heavily as a number to “trade on” – don’t forget what the ADP number is about: Marketing for ADP. How many times has ADP been mentioned in the press in the past week (or in this paragraph)? You almost can’t buy that kind of coverage.
If you want to put a negative spin on the employment report, you can always turn to the point that nonfarm payrolls are at best a coincident indicator – they tell you something about December, but maybe not much about next June. Of course, I have been hearing this argument for four months or so. Eventually it will be right.
But not today. Instead, the numbers are telling us that the year ended on a much more positive note than the permabears loudly insisted was happening. Like any good story, however, the permabears do circle around a truth – a few shaky data points came onto the picture, including a sub-50 reading on the ISM manufacturing index. And these data, not to mention the housing slowdown, were clearing starting to rattle some cages on Constitution Ave. From the minutes:
Several members judged that the subdued tone of some incoming indicators meant that the downside risks to economic growth in the near term had increased a little and become a bit more broadly based than previously thought…One member did not favor language that referenced only the possibility of additional policy firming and believed that, although the risks to inflation remained the predominant concern, the statement should emphasize that policy could be adjusted in either direction depending on the evolution of the outlook for inflation and economic growth.
By my estimate, the data we have seen since that meeting will likely keep that kind of talk at a minimum at the two day meeting later this month (that appears to be the market’s view as well). The ISM read on manufacturing revealed a rebound in December, with a solid gain in the new orders components. This may be a good omen for the advance durable goods report, which was soft in October and November (those reports, in fact, remain something of a concern to me). And the reports of the demise of the consumer continue to be revealed as premature. Real consumption posted a solid 0.5% month over month gain in November. Even if real consumption is flat in December, which I doubt, then household spending will gain at a 4% annual rate in the quarter. That would go a long way toward offsetting the housing drag, and helps explain why employment growth held steady during the quarter.
And, coming full circle, it is worth restating how strong this employment report is relative to Fed expectations, especially since Chicago Fed President Michael Moscow reminds us that the Fed has lowered its estimates of sustainable growth:
The recent changes in population growth and labor force participation imply that we need to change our benchmark for employment growth to something more like 100,000 per month...The slower growth of available workers and the rate at which trends in educational attainment and labor market experience add to those workers' productivity both imply slower growth in potential output. In the case of the former, the swing from an era in which labor force participation was growing around a tenth of a percent per year to one in which it is declining around two tenths percent per year implies a slowing in potential output growth. So do the slower improvements in the educational and experience composition of the labor force. Together, these suggest that the contribution of labor to potential output growth may have declined by a bit more than half a percentage point since the late 1990s.
David Wessel reiterated this point last week, as channeled by Mark Thoma, and I think it is an important one to keep in mind. Not only is the Fed anticipating growth will slow below potential (before gradually reaccelerating toward the end of the year), they have downgraded their estimate of potential. Employment growth in Q4 looks well ahead of what the Fed considers consistent with potential growth. Does this mean another rate hike is in the cards? Richmond Fed President Jeffery Lacker is clearly there, and it will be interesting to see if someone picks up his dissent at the next meeting (Moskow?). But I doubt the Fed overall would be comfortable enough with the outlook for housing to move in that direction anytime soon. They may be willing to hold tight while looking through the period of weaker data the economy experienced in the second half of 2006, but they aren’t ready to tempt fate any more than they already have.
Bottom line (I feel like a broken record): Talk of a rate cut has been premature. Any residual expectations that the Fed will cut rates in the first quarter should be fully dissipated. Underlying economic activity, relative to the Fed’s expectations, is pretty solid leaving the tightening bias in place. The housing bust should continue to put enough weight on the economy, however, to keep rate hikes off the table.
Northwest Beer Update: For those of you with a passion for the darker brews, especially on a long winter nights, it is worth trying to track down a bottle of Deschutes Brewery’s 2006 barrel aged reserve, The Abyss. It is ridiculously thick and sweet and complex. It’s sold in 22 oz bottles – and with an alcohol content of 11%, you only need one.