We still believe the employment numbers, as reflected in the monthly BLS release and the JOLTS reports, are among the more significant factors in the timing and pace of a Fed decision on raising rates. However, the weakening of the yuan in the short term has overwhelmed other factors affecting the global economy and central bank decisions—at least in the minds’ of the media. There are other factors that come into play as well, including the actual pace of both US and global economic growth, productivity, and commodity prices. Let’s try to put these in perspective.
The Labor Department reported employment increased by 215,000 jobs in July. This seasonally adjusted number was close to consensus, and kept the unemployment rate at 5.3%. While we expected the rate to remain unchanged, 215,000 was below our expectations. July is typically a layoff month as one can see in the tables below comparing seasonally adjusted results with the unadjusted numbers.
Factories often close down for maintenance, the educational systems close down for the summer, and many service organizations adjust to different patterns of activity for the summer months. Based on the unemployment claims and other evidence that companies were having a hard time finding qualified workers, thus holding onto employees, our expectation was for a larger seasonally adjusted number. We will see what the next two revisions bring. Note that last year in July, the unadjusted number, which was a bigger loss than this year, ultimately resulted in a significantly higher seasonally adjusted number. In the meantime, the workweek was up 2.7% over a year ago, and hourly wages were up 2.1%. That puts weekly wages up 4.9% from last year. July is a strange month because of the seasonal adjustments required to make a negative number into a positive number. This has to be a tough month for the BLS to estimate. This is a number the Fed can interpret any way it wants to.
China’s “floating” of the yuan (renminbi) and the subsequent weakening of the currency have added new elements to the view of growth in China and the state of currency relationships, particularly in the emerging markets. It has put additional pressure on hard commodity prices and raised issues around the time it would take for central bank inflation targets to be met. The timing of the move was interesting. Clearly, it is to China’s benefit to have a weaker currency in terms of its export markets. On the other hand, it does raise import prices and has an impact on both the Chinese consumer and company profit margins. As significantly, a freer floating renminbi is consistent with the desires of the IMF in considering the renminbi as a reserve currency. It is our view that while growth is slower in China, it is likely faster than growth in most of the developed world. It is not clear that a freer floating renminbi would produce a major weakening once the speculators are removed from the picture. This will bear watching—particularly as it relates to China’s economic growth. Let’s understand that, while the focus is on China’s major slowdown in industrial growth, services—which are more internally relevant—now represents close to 50% of the economy and continues to grow. I would urge readers to take a look at the recent macro outlook webinar we did with Henry McVey and Dave McNellis of KKR where China growth was discussed.
The Fed and Interest Rates
The Fed will have one more look at the employment numbers before its meeting on September 17. This will include the JOLTS report for July as well as the August employment numbers and revisions to earlier months. If these numbers are, at worst, neutral, odds are the Fed will start down the path of raising the Funds rate. Let’s also understand that the effective Funds rate will be the rate at which banks lend to each other to meet reserve requirements. For example, the Fed could raise the targeted Funds rate by 25 basis points, but the rate at which banks are prepared to borrow or lend could vary. We are entering an unusual period where results may be inconsistent with history, regardless of the timing of Fed rate increases. Odds are, once the Fed actually does raise the target rate, we will start hearing more about the Reverse Repurchase facility that has been set up to provide better control of the actual rate. All of this depends on what other data we see on the US and global economies. How much attention will be paid to what is happening in the rest of the world remains to be seen. Our view is the US data will be the driver of timing for the Fed. And, our view, shared by others is that the Fed will begin the process sooner than the futures would indicate. Whenever the process starts, it will be a gradual undertaking with some elements of experimenting and observing the data before additional rate increases take place. Getting us to this point has been an experiment. This will continue as we work ourselves back to “normal.” Experiments can lead to accidents. The combination of the variable global economic picture, low oil prices and related low commodity prices in general, systemic foreign exchange fluctuations, high valuations, low top-line revenue growth, and some wage pressure, will lead to larger variations in performance geographically, by sector and by individual company. It is a time to Pay Attention to more active managers on both the equity and fixed income side of the markets. Not only would I be looking for managers with lower correlations to the patterns we have seen in the last several years, I would also look for managers who can offer a measure of downside protection against the accidents we may see.