The jobs report for July painted a picture of the U.S. labor market that continued to improve with more positives than negatives. While another healthy jobs report does seem to complicate the Fed's slightly easy lean on monetary stance, the fresh-off-the-tweet potential trade escalation makes the downside risks to growth remain fluid in coming months. This has led us to now expect the Fed to lower rates one more time this year--likely at its next meeting in September. The Fed's least risky move is to protect against further slowing in investments (and subsequently growth) that come from trade uncertainty. That means the odds of a more than 25-basis-point (bps) cut by the end of this year has also increased.
First The Positives…
Jobs growth was healthy at 164,000 versus a 140,000 three-month average, and well above demographically determined long-run growth of about 100,000. The unemployment rate sustained its low level of 3.7%, and for good reasons: many people got jobs (283,000) and even more people (370,000) entered the labor force, with the labor force participation rate up to 63.0% from 62.9% in June (driven primarily by the 55+ age group). As we had expected, the average hourly earnings also saw a decent pickup in growth momentum with a 3.4% month-over-month annualized pace that translated to 3.2% year-over-year growth.
The slowing in jobs growth on a three-month average basis is amid no uptick in initial claims of unemployment benefits (layoffs). This could be either because firms are more cautious now about hiring or the supply of workers is limited, thus constraining potential of jobs growth.
That said, wage gains, now over 3% for the 10th straight month, help explain why consumers are happy. With the Conference Board Consumer Confidence Index reaching 135.7, the highest since November, and the share of consumers expecting an increase in incomes over the next six months climbing to 24.7%, the second-highest reading in this expansion, paychecks with more money means more money to spend at the mall, virtual or otherwise. The University of Michigan's Consumer Sentiment Index, another widely followed sentiment measure, was up 0.2 points to 98.4 in July, holding steady recent elevated readings and signaling sustained household spending momentum ahead.
…But There Were Some Metrics That Gave Us Pause
There were some very tentative softening signs that warrant close monitoring going forward, particularly: (i) the workweek hours (a leading indicator), which edged down to 34.3 from 34.4 in June (primarily due to goods-producing sectors; service providing held steady); and (ii) the prime-age (25-54) employment rate, which ticked down slightly to 79.5% from 79.7% (exclusively due to women), adding to the trend of this metric rolling off its peak in recent months. A prolonged drop in hours worked signals that businesses may reduce hiring, with layoffs and cutbacks in private spending to potentially follow. Meanwhile, the prime-age employment rate tends to peak before a recession.
Still, the report was strong enough to give us (and markets) reasons to be confident the domestic side of the U.S. economy is coasting along at a healthy pace with near-full employment, despite trade tensions. But the longer unfavorable global conditions and trade uncertainties persist, the more likely they are to weigh on business confidence and hiring. And this is where the growing downside risk lies.
Trade Is In The Front Burner Again…
We have already seen appreciably lower jobs growth (6,300 jobs per month) in the factory sector in the past six months compared with the prior six months when the sector was adding 19,800 per month. The trade war is part of the explanation, and that looks to be getting worse before it gets better.
On Thursday, President Donald Trump tweeted a threat to impose 10% tariffs on $300 billion of imports from China effective Sept. 1. This would extend the existing tariffs on approximately $250 billion of imports that focused largely on industrial goods to tariffs on virtually all Chinese imports, including a wide array of consumer goods. He later added in a press conference that the tariffs could go "well beyond 25%…but we're not looking to do that necessarily." Then, in less than 24 hours, in an interview with CNBC he said that he is "open to delaying or halting the 10% tariff on 9/1" if China takes positive action.
While we still wait for an official notice from the office of the U.S. Trade Representatives (USTR), imports from China are now likely to rise in August as firms may front-load goods to avoid the tariff hike in September. We estimate the imposition of 10% tariff on additional $300 billion of imports could reduce U.S. growth by a further 15 bps going into 2020 (our forecasts published in June had real GDP grow 1.8% in 2020). On its own, this is not enough to threaten the U.S. expansion. However, on top of the other protectionist policies already in place and with storms brewing over the U.S.-EU trade dispute, the U.S. economy may begin to feel the pinch from these various trade clashes. Secondary effects from reduced business confidence and a tightening of financial conditions could exacerbate the trade shock.
…Justifying The Fed's Cut And Supporting An Easy Monetary Stance
Higher tariffs on Chinese imports, should they be levied, could impart some upward pressure on CPI inflation in the near term. In our view, however, the Federal Reserve would likely look through any temporary increase in inflation that was caused by a one-off increase in tariffs rates.
Rather, any signs of a slowing effect that the trade dispute would impart on the economy likely would lead to eventual Fed rate cuts. Just as important, the hit to longer-run productivity growth coming from sustained trade tension will be a long-term issue that will also work to lower the longer-run steady state of interest rate (r*).
Indeed, both of these issues were front and center in the Fed's well-telegraphed so-called "mid-cycle adjustment" to monetary policy coming out of July 31 (Wednesday) Federal Open Market Committee (FOMC) meeting. The Fed cut its policy rate by 25 bps to 2.0%-2.25% and emphasized that trade uncertainty was the key factor driving Fed easing. (The following day, the president promptly delivered it.)
Consistent with the accommodative stance, the committee also decided to end the reduction in its balance sheet in August, which had been underway since October 2017. Previously, the FOMC had said it would end its balance sheet run-off in October. Total reserve balances (central bank's liabilities) have declined from nearly $2.8 trillion at the peak in 2014 to less than $1.49 trillion currently. This constitutes about 7% of GDP, which is well above the roughly 0.1% of GDP prior to 2008 and looks to become the new normal going forward. The size of total assets (equals liabilities) is at $3.8 trillion, or 17.8% of GDP--down from 25% of GDP at its peak in 2014. From here on, we assume a gradual increase in the Fed's balance sheet to accommodate normal growth in the Fed's liabilities (primarily, banknotes and reserves), close to nominal GDP growth rate.
While taciturn about its next moves, the Fed's message does seem to suggest that it has a slightly more-accommodative stance than we previously thought. The Fed said that risks of further escalation in trade tensions amid soft inflation explain the cut and seem to indicate that additional easing this year will be contingent upon whether trade disputes will heighten or ease off. Now, with the Trump Administration planning to slap 10% tariffs on remaining $300 billion of imports from China starting Sept. 1, 2019, just as the U.S.-EU trade dispute is expected to heat up, the odds of another rate cut this year have grown.
|Review of economic indicators released in the past two weeks (July 22, 2019 - Aug. 2, 2019)|
|Latest period||Jul-19||Jun-19||May-19||Level year ago||% year-over-year|
|Jobless claims (four-week average)||7/27/2019||211,500||222,500||217,500||215,250|
|Unemployment rate (%)||July||3.7||3.7||3.6||3.9|
|Nonfarm payrolls (change in '000s)||July||164||193||62||178|
|Average hourly earnings, All employees (% change)||July||0.3||0.3||0.3||3.2|
|ADP employment (change in '000s)||July||156||112||46||284|
|Participation rate (%)||July||63.0||62.9||62.8||62.9|
|Consumer spending and confidence|
|Consumer Confidence Index (Conference Board)||July||135.7||124.3||131.3||127.9|
|Personal income (m/m, % change)||June||0.4||0.4||4.9|
|Personal disposable income (m/m, % change)||June||0.4||0.3||4.7|
|Consumer spending (m/m, % change)||June||0.3||0.5||3.9|
|Savings rate (%)||June||8.1||8||7.6|
|Consumer Sentiment Index (UMICH)||July||98.4||98.2||100||97.9|
|Business activity and sentiment|
|Durable goods order (m/m, % change)||June||2.0||(2.3)||(1.6)|
|ISM Manufacturing Index (level)||July||51.2||51.7||52.1||58.4|
|Chicago Purchasing Manager's Index||July||44.4||49.7||54.2||64.1|
|Housing and construction|
|New home sales ('000s)||June||646||604||618|
|Existing home sales (SAAR, mil. units)||June||5.27||5.36||5.39|
|Pending home sales (%, m/m)||June||2.8||1.1||1.6|
|Construction spending (%, m/m)||June||(1.3)||(0.5)||(2.1)|
|Trade balance of goods and services ($ bil.)||June||(55.2)||(55.3)||(47.4)|
|Exports goods and services ($ bil.)||June||206.3||210.7||211.0|
|Imports goods and services ($ bil.)||June||261.5||266.0||258.4|
|PCE Price Index (m/m % change)||June||0.1||0.1||1.4|
|Core PCE Price Index (m/m % change)||June||0.2||0.2||1.6|
|Q4 '18||Q1 '19||Q2 '19|
|GDP (%, SAAR)||1.1||3.1||2.1||2.3|
|Employment Cost Index (q/q, % change)||0.7||0.7||0.6||2.8|
|Source: U.S. Bureau of Labor Statistics, U.S. Bureau of Economic Analysis, U.S. Census Bureau, Institute for Supply Management, and ADP Research Institute. Notes: Jobless claims is weekly data.|
|Economic Release Calendar|
|7-Aug||Consumer credit (bil. $)||Jun||17.0||16.5||17.1|
|PPI (ex-food and energy) (%)||Jul||0.2||0.2||0.3|
|12-Aug||Treasury budget (bil. $)||Jul||(105)||(103.5)||(8.5)|
|CPI (ex-food and energy) (%)||Jul||0.2||0.2||0.3|
|14-Aug||Export Price Index (%)||Jul||0.0||(0.2)||(0.7)|
|Import Price Index (%)||Jul||0.1||0.0||(0.9)|
|15-Aug||Retail sales (%)||Jun||0.2||0.3||0.4|
|Retail sales (ex-auto) (%)||Jun||0.4||0.5||0.4|
|Nonfarm productivity (prelim) (%)||Q2||1.4||1.3||3.4|
|Unit labor costs (prelim) (%)||Q2||1.8||1.9||(1.6)|
|Philadelphia Fed Index||Aug||12.0||11.1||21.8|
|Empire State Index||Aug||6.0||5.0||4.3|
|Industrial production (%)||Jul||0.3||0.4||0.0|
|Capacity utilization (%)||Jul||78.0||77.9||77.9|
|Business inventories (%)||Jun||0.2||0.2||0.3|
|16-Aug||Housing starts (mil.)||Jul||1.261||1.260||1.253|
|U. Mich. Consumer Sentiment (prelim)||Aug||98.6||98.9||98.4|
The views expressed here are the independent opinions of S&P Global's economics group, which is separate from, but provides forecasts and other input to, S&P Global Ratings' analysts. The economic views herein may be incorporated into S&P Global Ratings' credit ratings; however, credit ratings are determined and assigned by ratings committees, exercising analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.
|U.S. Chief Economist:||Beth Ann Bovino, New York (1) 212-438-1652;|
|U.S. Senior Economist:||Satyam Panday, New York + 1 (212) 438 6009;|
|Research Contributor:||Arun Sudi, CRISIL Global Analytical Center, an S&P affiliate, Mumbai|
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