A Merry May for Jobs
The first day of June brought a fresh round of data that point to stronger growth ahead for the U.S. economy. Reports on jobs, income, and factory-sector sentiment all signal that the inventory downdraft of the 2006 fourth quarter and 2007 first quarter has reached an end.
We still aren't out of the woods with housing, as suggested by a weak pending home sales report for April, but the removal of the inventory downdraft should allow gross-domestic-product growth to bounce above 3% in the second quarter. The prospect of a second-quarter bounce in growth, along with persistent signs of inflation, will keep the Federal Reserve on its toes in the coming months.
The key report on June 1 was the U.S. jobs report for May. Nonfarm payrolls rose 157,000 in the month, from a revised 80,000 in April (from 88,000 initially), while the 177,000 surge in March was revised down slightly to 175,000, to leave a net two-month revision of –10,000. The unemployment rate held at 4.5%. Average hourly earnings rose 0.3%. The workweek expanded to 33.9 hours from 33.8.
Payroll Bounce Ahead
Among the components, manufacturing shed another 19,000 jobs while construction employment was flat. The service-producing sector added 176,000 jobs, with a 22,000 rise in government jobs. The report revealed a solid round of workweek and hours-worked data and a slight overshoot of payroll growth relative to expectations as well, to leave clear evidence of a bounce in production in the current quarter.
To be sure, the payroll figures on a quarterly basis are posting the widely expected gradual slowdown into 2007, but with little evidence of the jarring downward shift feared in the markets. We expect payroll growth to average 124,000 in the second quarter with an assumed 135,000 payroll increase in June. A small payroll growth bounce is likely in the third quarter if the inventory cycle is indeed turning in the current quarter.
The 0.3% hourly earnings gain boosted the year-over-year increase to 3.9%, and this will stoke Fed concerns about the ramifications of a tightening labor market for wage costs. The construction employment data have continued to outpace expectations of sharp declines for this sector, with May's unchanged reading leaving a notably sideways trend thus far in 2007.
Paying for Gas
The May factory payroll drop, alongside 0.1-hour declines in both the factory workweek and overtime, implies restraint in May industrial production, which we peg as unchanged following the big 0.7% April surge. The gain should leave a solid 3.6% growth clip for the index in the second quarter, following the 0.9% pace of the first quarter and 1.5% rate of decline in the 2006 fourth quarter. These figures are clearly tracking the inventory reversal, with a pop in the second quarter following declines in the two quarters of inventory unwind.
Meanwhile, a June 1 report showed personal income declining 0.1% in April (median 0.3%), while consumption posted a 0.5% gain (median 0.4%). Data in the May employment report suggest a 0.5% gain in personal income is in the pipeline for May. As it stands, strength in income growth through May is a big factor fueling robust growth in consumption and retail sales, as is the runup in gasoline prices that will boost the nominal figures for gasoline service station sales.
The headline figure for the May Institute for Supply Management manufacturing index, also released June 1, improved to 55.0 (median 54.0) from April's better-than-expected level of 54.7. The improvement on the month leaves the index at the highest level since last April, which supports the view that activity has jump-started as the inventory downtrend reverses course.
Balance of Risk
In total, strength in today's jobs report for May, alongside strength in the income and ISM releases—as well as the May 31 reports on GDP, Chicago PMI, initial claims, and construction spending (see BusinessWeek.com, 5/31/07, "Weak GDP Points to Stronger Q2")—provides clear evidence that the GDP downdraft from the inventory correction has come to an end.
With stronger readings in the headline GDP figure, and a likely reading for second-quarter GDP of 3% or higher, the Federal Reserve will face considerably downgraded economic risks as assessed in the two-day June Federal Open Market Committee meeting. But the improved core inflation figures over the past two months are also likely to prompt a downgrade of perceived inflation risks. We expect that the general diminution of risk in both directions will still leave a bias in the Fed's balance of risk in favor of inflation fears.
As we approach the August-September period when the various year-over-year inflation measures will lose the benefit of easy comparisons, we continue to believe that the Fed will be forced to reconcile its aggressive anti-inflation rhetoric with the stubbornness likely to remain in the reported inflation data—with a rate hike at the end of the third quarter the likely result.