That Incredible Shrinking Slowdown

Much stronger than expected, April's jobs data signal that the Street's assumptions about GDP are on the low side

By Michael Englund

What happened to the "soft patch?" Market observers who were expecting the May 6 release of the April employment report to reflect the weakness seen in other recent economic data received a jolt. Nonfarm payrolls surged 274,000 on the month, well above economists' median forecast of a 175,000 rise. And the hefty increase in April followed big upward revisions in the prior two months, with March job growth raised to 146,000, from 110,000, and February showing a big bump to 300,000, up from 243,000.

Nearly all of the important indicators included in the April report were strong. They also help set a solid trajectory for 2005 overall. Indeed, the sheer breadth of the data's strength should soothe market concerns about the much-discussed "soft patch" in U.S. economic growth. And with a solid round of April economic output indicators on the horizon, it's unlikely that any second-quarter weakness could be very deep.


  A closer look at the report shows that the average workweek rose to 33.9 hours from 33.7. This helps mitigate the unusual weakness in hours worked that has plagued employment data over the past year. The factory workweek climbed 0.1 hours, which more than offset the effect of a modest factory employment drop of 6,000 on prospects for April factory output.

The 0.3% rise in hourly earnings was above-trend and extends the gradual uptrend in year-over-year wage growth to 2.6% in the last two months from the 1.5% trough in March of last year. Payroll growth was solid across most industries. The unemployment rate held at 5.2%.

We at Action Economics see two important takeaways from the April report. First, the strong payrolls increase in the month and big upward revisions in February and March have closed the gap between this defining measure of labor market strength and other, more volatile measures, such as weekly initial jobless claims.


  Second, and perhaps more important, employment also revealed a solid boost for many of the component measures that are source figures for other monthly reports, pointing to a notably robust round of production and income numbers for the month.

The personal income report is now poised to reveal a big 0.7% gain in April, which reverses some of the restraint of the last two months to leave a robust income trajectory as the country enters the second quarter. Disposable income is now poised for an above-trend 6% growth clip in the second quarter.

Strength in the income figures for April is signaled by two key components of the jobs report: An above-trend 0.3% wage gain, as well has a huge 0.9% surge in the hours-worked index. The hefty April hours-worked gain implies 4% growth in total hours worked in the second quarter, even if the workweek data post a pull-back to 33.8 hours in May and June.


  The last time a quarterly gain this large was recorded was in the second quarter of 1997, when GDP posted a 6.2% growth clip. A flat productivity figure for the second quarter will be needed to create any slowdown in GDP growth during the quarter to a 4% clip or lower, now widely assumed on Wall Street.

At Action Economics, we'll stay with our cautious 3.5% second-quarter GDP forecast until we get more source data for the quarter, and until we see what the inventory and trade figures will imply for the already suspect 3.1% GDP gain in the first.

As it stands, we expect an upward bump in the first-quarter figure to 3.3%, but there is significant risk that strong inventory figures in March, or a bounce in that month's trade deficit, could push gas-price-related first-quarter restraint on growth back into the second quarter, where economists initially expected to find it.


  The industrial production figure for April should reveal a modest 0.1% gain due to weakness in vehicle assemblies and utility output. This measure suggests that weakness is more likely to materialize in the final GDP data for the second quarter than the first.

In total, however, the numbers in the April jobs report imply substantial upside possibilities to the market's current GDP assumptions for the first two quarters of the year, and a substantial likelihood that the current perceived "soft patch" will completely evade the quarterly GDP reports.

The result would not be much different than in the middle of last year, when the "soft patch" phrase was coined by Fed Chairman Alan Greenspan to describe what most market economists viewed as a broad and likely sustained slowdown in the economy -- one that turned out to be modest and temporary.


  Although the April employment data really said little about the likely impact of concerns over high and uncertain gasoline prices on household and business demand, the report will likely change the perceptions about the "soft patch" story.

Action Economics has argued that the retail sales and durable goods data for May and June will be crucial in determining the likely sustainability of any demand impact from the upside gasoline price shock, and this remains the case. But the surge in payrolls will likely push these concerns to the background, as strong production data for April will make it hard to argue a convincing case for the "soft patch" notion.

How will Greenspan & Co. react? A few Fed watchers now suspect the central bank could quicken its pace of policy normalization as soon as the Sept. 20 FOMC meeting and push rates up by a half-percentage point to a 4% target. Others, including ourselves, continue to think the best guess is for a still-"measured" approach through Greenspan's tenure, although all bets are off if the pace of inflation begins to quicken.

Englund is chief economist for Action Economics

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