Last week was quite the rollercoaster – one I suspect Fed policymakers will find consistent with their general outlook. The better than expected gains in nonfarm payrolls supports their claim that first quarter weakness will prove to be temporary, while the commodity price rout will give them the breathing room on inflation they felt they needed. This combination should keep the Fed locked on their current policy trajectory.
Consider last week’s data flow. It began with headline ISM manufacturing coming in 60.4, a tad below the previous month’s 61.2 but still respectable. The internals were arguable a bit weaker, although that should not be unexpected given such solid numbers in previous months – it is difficult to keep diffusion indexes moving upward at a certain point. All in all, another solid read on the manufacturing sector that showed no evidence of substantial slowing.
That optimistic view, however, was quickly upended by the ISM’s service sector report, which revealed a staggering 11.4 percentage point decline in the new orders index. This appears to be an artifact of commodity-price induced uncertainty. From the overall comments:
According to the NMI, 17 non-manufacturing industries reported growth in April. Respondents' comments are mixed about overall business conditions; however, they are mostly positive. Respondents' comments also indicate concern over rising fuel costs, commodity costs and the lingering uncertainty about the economy."
Interestingly, consider this note in the new orders category:
Comments from respondents include: "Customers are more optimistic" and "Improved market conditions."
I am not sure what to make of these comments, as they are not consistent with the new orders decline. Also note retail trade was the only sector reporting decreased business activity for the month, suggesting much strength otherwise. That does make sense given the likely impact of high gasoline prices on household budgets. Note the early read on retail sales was better than expected, but erratic. From the Wall Street Journal:
The 25 retailers tracked by Thomson Reuters showed an 8.9% sales gain for April at stores open more than a year, also known as same-store sales. The results beat analysts' expectations for an 8.4% rise and were the best showing in a year. The figures, however, were erratic, with a number of high profile retailers missing expectations.
Target Corp. (TGT) posted a 13.1% rise in April same-store sales, just beneath the 13.2% that analysts expected. The mass merchant said the results were somewhat below its own expectations as consumers were "very cautious" in their spending up until Easter. Chief Executive Gregg Steinhafel added that customers "face increasing pressure on their household budgets due to higher energy costs and increasing prices of food, apparel and home merchandise."
We get the official read on retail sales later this week.
Initial unemployment claims shot up, although the gains were attributed to noise in the data. Still, coming on the back of a general increase in claims in recent weeks, the report seemed to foreshadow a weak employment report. That was not exactly the case, as nonfarm payrolls posted a 244k gain, 268k in the private sector. The goods producing industries added 44k, with 29k in manufacturing alone, consistent with ongoing strength in that sector. Retail sales gained 57.1k, professional and business services 51k, and health care 41.8k. Possible red flag – temporary employment shed 2.3k workers
Notably, despite the employment gains and testifying to the overall low level of labor utilization, wage inflation remains non-existent, with average hourly earnings climbing just 3 pennies. Inflation hawks move along, nothing to see here.
The household survey was not quite as “bright.” Number of employed declined, number of unemployed and not in the labor force both rose. The net impact was to leave the unemployment rate slightly higher and the employment to population ratio slightly lower.
In short, the story remains the same – by the measure of nonfarm payrolls, labor markets are gaining momentum, but at a depressingly slow pace of improvement given the depth of the labor market hole. Yet, by in large, policymakers remain focused on the improvement, not the level. And that pushes policymakers into neutral gear, a point reiterated last week by New York Fed President William Dudley:
“The weakness of real GDP growth in the first quarter probably will prove temporary,” Federal Reserve Bank of New York President William Dudley said. “There are many reasons to believe conditions are in place for stronger growth in the coming months in the nation and the region,” he said.
While Dudley declined to comment on the monetary policy outlook, he noted “the recovery remains moderate and we still have a considerable way to go to meet the Fed’s dual mandate of full employment and price stability,” which suggests he sees no urgency to move to a more restrictive monetary policy stance.
Dudley declined to comment on the commodity price rout:
Dudley refused to comment on the recent activity in commodity markets. In response to a question, he said “I think I would never comment on short-term market price movements, and I don’t think today’s a good place to start.” He explained he’s more interested in medium to long-term trends, and he added “I would be hesitant to put much weight on very near-term development in terms of that changing the picture dramatically in terms of the broader issues. We’ll see how things go.”
He is not placing much weight on the drop because he placed little weight on the run-up in recent weeks. He is trying to look through the short-term gyrations to the underlying trend. Rational.
For the more hawkish policymakers, however, the short-term gyrations are important, and the decline in commodity prices in general, and oil prices in particular, should keep them at bay. A drop in headline inflation – Jim Hamilton estimates that gasoline prices could drop as much as 40 cents in the coming weeks – would leave them on shakier grounds when it comes to pushing for tighter policy sooner than later.
Bottom Line: The Fed believes Q1 weakness was temporary. I doubt this position changed much despite a wild week of data. Indeed, much of the weakness could be tied back to commodity prices, which look to be reversing course. Those declines will also silence the loudest screeches of the hawks. Most importantly, nonfarm payrolls surprised on the upside. Ultimately, that 244k gain is the life preserver they will cling to in an otherwise stormy sea.
