The caveat in US payrolls
Notions of a US growth scare were apparently banished on Friday with a bullish payroll report for July helping drive US equities to a new high and causing the dollar to rally strongly.
Some 255,000 jobs were added — far better than the expected 185,000 — while a cycle-high average hourly earnings gain of 2.6% YoY points to strong domestic demand.
So how to square this data with the far less cheery 2Q16 GDP report, released the previous week, which showed the US expanding at a miserly 1.2% QoQ annualized, with consumption being the only growth driver?
1) As every economics student knows, payrolls are a lagging indicator (see chart below) which tracks general output with a lag of about three months. After all, firms respond to demand shifts by cutting activity and so labor. The point with the July payroll is that while the number of employed US workers was higher than expected, the YoY change has declined to 1.7% from 2% in March, which is consistent with the trajectory of GDP.
2) As with the broader economy, the labor market has pockets of strength and also weakness. The small slowdown in hiring by consumer facing firms is likely due to tightness in the jobs market as shown by NFIB job openings, whose last reading was near a cycle high. By contrast, a weak industrial sector means that metal bashers, energy players and business service providers are tending not to hire workers. The “production oriented” segment of the jobs market tends to be volatile and pro-cyclical (see chart below); in the early phase of the past two recessions it contracted, while the consumer facing segment stayed strong. Hence, it is concerning that the bad outlook for workers in the business services sector points to general conditions similar to those seen in the lead-up to past recessions.
Therefore, the latest payroll report is not a reason to go allin bullish, but rather a confirmation that the US economic outlook is gradually worsening, albeit slowly.
On a smoothed basis, the labor market has stopped improving, but cannot yet be said to be deteriorating. Although, the US economy does not face an imminent recession risk, one consequence of Friday’s jobs report is that the market is now pricing in a greater chance of US interest rate hikes this year. Given this cocktail of uninspiring growth, likely policy headwinds and rich valuations, investors should consider cutting exposure to risky US assets.