Beyond the March payrolls ‘soft patch’
From a strictly economic standpoint, the market’s indifference to the payrolls was completely rational. This is because a “miss” of 100,000 in any single month’s payrolls means literally nothing. According to the Bureau of Labour Statistics, the monthly change in payrolls has a sampling error of 120,000 at a confidence level of 90%. What this means in plain language is that 10% of the time (or one month in every ten) the announced payroll figure will be 120,000 lower or higher than the true growth that occurred that month.
Such sampling errors are the simplest and most convincing explanation of the soft patches that have spooked investors about once a year for the last seven years. These employment soft patches have generally not coincided with other indicators of economic weakness, such as the monthly ISM surveys. Nevertheless, every year since the start of the post-crisis expansion, they have triggered mini-panics about US recession and the ongoing abject failure of monetary policy.
The inaccuracy of monthly payrolls has nothing to do with bureaucratic incompetence or the erratic behavior of the US economy. The reason is simply that the monthly figures investors follow so obsessively are the difference between two vastly larger numbers: the total payroll employment last month and the total employment the month before. These total monthly figures are each around 110 mln, and they are what the statistical samples actually estimate. If one of these estimates is wrong by as little as 0.1%, the resulting monthly payroll growth will be out by 110,000. Not surprisingly, such tiny sampling errors occur quite often. In fact, it is a miracle of bureaucratic virtuosity that on average they happen only once every ten months.
The absence of any recession panic this time around, despite waning expectations of any significant fiscal stimulus from Donald Trump’s administration, could be credited to enthusiastic post-election animal spirits among businesses and investors. More plausibly in my view, it is attributable instead to the consistent flow of solid economic data since last summer, not only from the US, but also from Europe, China, Japan and many emerging markets. In either case, the robust state of financial and business confidence should help to sustain the global risk-on trends that accelerated after the US election but then fizzled out in March.
Of course, if the Wicksellian view about an approaching credit squeeze presented recently turns out to be right, then the investor complacency about the chances of a slowdown will actually increase the odds of a full-scale recession and a major market correction.
In my view, however, the positive balance of recent economic data, and the way that economic strength has been spreading from the US to the rest of the world, suggests that the global expansion and the risk-on behaviour of financial markets is much more likely to continue than suddenly reverse.
But if the global expansion and equity bull market do continue, their geographical pattern will gradually change. With US equities already fully valued, with the US business and profit cycles already far advanced, and with US monetary policy inevitably continuing to tighten, the scope for further gains in the US seems limited. In Europe and many emerging markets, by contrast, business cycles are only just entering their expansion phases, profits have plenty of scope for improvement, inflation is not on the horizon, and monetary policy is years away from any substantial tightening.
In short, in the US the Goldilocks conditions that investors have found so profitable will probably tip towards overheating; but in the rest of the world the Goldilocks period has only just begun.