Employment Numbers Surprise Most and Change Fed Expectations (Again)

In contrast to February, March employment numbers surprised on the downside, with adjustments to January and February reducing employment for the first three months to a seasonally adjusted average rate of 197,000, down from 220,000 previously. As we said last month, we would have expected some payback as the true impact of the weather, the port strike, and what was happening in the oil patch worked its way into the revised numbers and the month of March. Still, this was a surprising number on the low side.

On the wage front, however, hourly earnings were up 0.3%. This is a little suspect given the layoffs and likely reduction of hours related to the oil patch where earnings are quite a bit higher than the average. If true, combined with average weekly payrolls, it pushes incomes up at more than a 5% annual rate for the first quarter. The anecdotal evidence, to some extent, continues to support that the labor markets are tight, and some companies are responding by raising hourly wages and adding more training for employees. The headline companies have been in retailing—Walmart and Target. McDonald’s has joined the crowd where it could, raising wages 10% in its company-owned outlets. These companies are seeing something in the difficulty of retaining employees with turnover hurting the quality of service. Given what we are seeing on the corporate revenue front, this likely reinforces the view that profits will be disappointing.

The Fed will continue to be data-driven. The employment numbers and the likely GDP print may keep the Fed on hold beyond mid-year, or it could simply change the rate at which fed funds will rise. We are watching the employment numbers, wages, and commodities. I hate to say that we need more data. Maybe April will provide that. The surprise could be a bottoming on the commodity front aided by growth in Europe and parts of Asia and some tempering of the rise of the dollar. The bearish technical trends of the hard commodities, particularly the industrials, would lead one to believe we are in a global recession. I don’t think so. This bears watching, but it most likely indicates that China, the big marginal buyer, is weaker than general expectations. In addition, energy is a major input into extraction and smelting in all of the metals. The lower energy prices reduce significantly the variable cost of production. Mines or smelting activities, which have been operating on the margin, have likely seen that margin improve thus pushing output higher than it might have been otherwise. If there is a variable contribution to overhead production continues. Please take a look at our recent Perspectives update on “What More to Expect in 2015…” for more on this topic and others. In the meantime, the activities in the commodities sector, combined with currency fluctuations, have been interesting for managed futures managers. The variations in performance among equity sectors have been a boon to active equity managers. And, fixed income managers more focused on absolute return have had choices to make. Worth paying attention to this changing environment.

Now, for the geeks who managed to make it through last month’s observations on employment, here’s an update:

The actual unemployment rate fell 0.08% in February—not quite enough to push the overall rate down another tenth, but close. As we pointed out last month, the unrounded February rate was 5.545%. March was 5.465%. Twenty-five thousand more employed would have taken the rounded number down to 5.4%. That brings us back to the seasonal adjustments, which we discussed last month. The table from last month has been updated below through March.

TBL_Blog_OTM Change_Jan14-Mar15_040614

As one can see, the seasonal adjustments are significant, and vary year-to-year and revision-to-revision reflecting new data; different birth/death numbers for small businesses; adjustments for unusual events (e.g., weather); and other factors. I will point out that, historically, the big unadjusted reduction in every January for the last several years is almost completely made up by the total of the subsequent three months. If that happened again this year and was precisely equal to 2,818,000, the unadjusted number in April would ultimately be 1,158,000. April is a big hiring month. How that translates into seasonally-adjusted numbers is not as clear. Our view is that the labor market is tight. We have some adjustments to live through out of the oil patch, but we will likely find ourselves back into economic numbers that indicate a growing economy here, but with different sectors providing the investment opportunities relative to what was experienced up until the end of US QE.

Employment numbers surprise most and change Fed expectations

Don’t expect equity-like returns in traditional fixed income.

I am just about to put out an update on our “What to Expect in 2015…” piece on Altegris Perspectives. However with a surprisingly good jobs report out this past Friday it is worth a specific comment on the report for those who care.

The conclusion from the employment numbers lends some support to an increase in Fed Funds rate at mid-year. The early reaction of the US yield curve – a 10bps upward movement in 2-year interest rates – indicates that market expectations are moving in that direction as well. I think the Fed will continue to be data driven, but this data point leans in that direction. It reinforces our view that fixed income portfolios, in particular, require a fresh look with a move toward a more absolute return approach. There also needs to be a realization that equity like returns experienced in fixed income are most likely a thing of the past without taking on equity-like risk or even greater. That is not the role of fixed income in a portfolio. With that said, let’s look at the employment numbers.

The seasonally adjusted employment number showed a 295,000 increase for February and a decline in the unemployment rate to 5.5%.  This compares to a consensus among economists of a 230,000 increase and a decline in the rate to 5.6%.  The only negative elements in the report were a small decline in the participation rate and a modest 0.1% increase in the hourly wage number. Although, with the average work week up, more additions to the employment rolls and a 0.5% increase in last month’s wage number, this is a positive for incomes. The latest Beige Book shows indications from most of the districts of rising difficulty finding the skill sets to match needs and a resulting pressure on wages. The impact of lower activity in the energy sector is expressed as a concern, but is not necessarily showing up fully in the numbers.

One has to be somewhat sensitive to these first numbers given the weather impact and the major seasonal adjustments in these early months of the year.

For the geeks out there, here are a few considerations:

The actual unemployment rate before rounding was 5.545%. This just barely rounds to 5.5%. A change in 10,000 more unemployed coming from a higher participation rate or maybe a better count on losses in the energy sector would have pushed that number higher. No doubt the Federal Reserve is aware of all this.

We are also dealing with seasonally adjusted numbers. The actual increase in employment in February, 2015 was 903,000 which was seasonally adjusted to 295,000. In January there are actually major declines in employment. The employment rolls were down in January this year at roughly the same number as last year, -2,821,000 vs.  -2,836,000 in January 2014.  Last year that decline translated, seasonally adjusted, to +129,000 additions to the employed work force. This year, with new seasonal adjustments the number translated to +239,000.  See the table below to get some sense of the monthly differences between seasonally adjusted and unadjusted numbers as well as the historical pattern of revisions.

Nonfarm Payroll Employment Table

There may be some payback in March. While the weather prevented folks from coming to work or visiting stores most of those employed but not working were still on the payroll. There may be more adjustments to employment levels once the impact of the weather requires a fresh look by employers at costs relative to lost income as well as some catchup on the energy sector.

The market focuses on every new number or headline that comes out and tries to discount that into values instantaneously. It isn’t just the Fed that tries to be data-driven. The employment report is one set of data. It, at the moment, supports the labor side of the Fed’s mandate and can be a lead indicator on the inflation front. It is another signal requiring one to Pay Attention. More to come.