The caveat in US pay­rolls

Financial Mirror (Cyprus) - - FRONT PAGE - By Tan Kai Xian

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.

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