Claims keep declining

First-time claims for unemployment came in as expected, but the more important news is that they continue to trend lower.

This chart shows the long-term trend of claims (using their 4-week moving average) and the 52-week moving average of that. Clearly, the trend remains down. There is no sign at all of any deterioration in the labor market as of last week. There is thus no reason to think that the economy can't continue to grow by at least 2%.

As the above chart of 10-yr Treasury yields shows, rates have moved sharply higher in the last few months, and are significantly higher than they were at last summer's low. This, despite valiant efforts by the Fed to purchase Treasuries and MBS. It's worth repeating that this is not really a paradox, since it merely goes to show that the Fed has very little power to artificially depress interest rates. Fed purchases may seem large, but they are very small in relation to the outstanding stock of bonds, all of which are priced off Treasuries. The market sets bond yields. The market has taken interest rates higher because the market has more confidence in the economy's ability to grow. Thus, QE makes less sense, and the tapering of QE seems reasonable. The bond market is even looking ahead to the day when the Fed not only stops buying bonds but begins to raise the interest rate it pays on reserves.

According to Fed funds and Eurodollar futures contracts, the market doesn't expect the Fed to raise rates meaningfully for the next two years (June Fed funds futures currently reflect a tightening of only 25 bps, to 0.5%). According to the market's current thinking, therefore, the tapering of QE may take many months, and the beginnings of a modest tightening could be two years in the making. This is hardly a scary picture. Indeed, if the economy continues with present trends it's difficult for me to see the Fed waiting as much as two years before beginning to adjust rates higher.

The market is getting used to the idea that interest rates are going to move higher, and it's all due to the market's new-found realization that the economy is on more sustainable growth path, even though that growth is very slow compared to what it could be. The more evidence—such as declining claims—we see that the economy is avoiding a recession, the more reason there is for interest rates to move higher. That's not a threat to growth, it's a validation of growth, however modest.

The facts about part-time employment

It's fashionable to argue that there have been more part-time jobs created this year than full-time jobs, and that this is therefore a miserable recovery. But a word of caution is in order: the jobs statistics—like all statistics, especially those that are subject to seasonal variations and revisions, and are sourced using different methodologies such as the jobs statistics are—can be manipulated to prove a point, so you have to take claims like this with a grain of salt. The truth is more likely not as bad as it is made out to be. Here's my attempt to be somewhat impartial.

First, let me briefly note that while all jobs statistics come from the Bureau of Labor Statistics, the data are collected in two very different ways. The Establishment Survey relies on sending out a form to known businesses, and it attempts to adjust for new startups that are not known at the time of the survey. The Household Survey relies on a telephone survey of thousands of households for its data. Both have their strengths and weaknesses. Since the Establishment Survey only attempts to uncover the number of jobs, it tells us nothing about who is not working. The Household Survey, in contrast, asks a random sampling of the population if they are working or not, how many hours they are working, and if they are not working whether they are looking for work or not. That's why the unemployment rate comes from the Household Survey, but the most commonly-referenced estimate of total jobs created comes from the Establishment Survey.

As the above chart shows, the Establishment Survey is much less volatile than the Household Survey, although the two tend to tell the same story over time. For example, so far this year the household survey shows the economy has created 975K jobs, but the establishment survey has uncovered 1,347K new jobs. That's quite a big difference—38% more jobs according to the establishment survey. But from the low point in employment (i.e., the end of 2009), the establishment survey shows 6.67 million new jobs and the household survey shows 6.24 million. That's not a very big difference at all (only 7%), especially considering that two-thirds of the time the number of jobs added or subtracted each month according to the household survey can be as much as 300K. The household survey might very well "catch up" to the establishment survey in the next few months.

And if we look just at jobs created by the private sector, the two surveys are very close over longer periods. As the chart above shows, according to the household survey, there have been 7.27 million new private sector jobs created since the end of 2009, while the establishment survey finds 7.29 million.  Note also how much more stable the establishment survey is than the household survey.

So let's assume that the household survey gives us a decent idea of how many full- and part-time jobs there are (that's not hard because it's our only source for this statistic), while the establishment survey does a good job at finding total private sector jobs. The public sector is not apt to rely as heavily on part-time employment as is the private sector, so this is arguably a valid comparison.

The above chart compares the level of part-time employment according to the household survey to the ratio of this same measure to the level of total private sector employment according to the establishment survey.

Several things to note:

1) Since the end of the last recession, the level of part-time employment has risen by about 0.7 million. So far this year, it has increased by 0.73 million. In other words, substantially all of the post-recession rise in part-time employment has occurred this year.

2) So far this year, the household survey says that full-time employment has only increased by about 0.22 million, so from this it follows that new part-time jobs have far outnumbered full-time jobs. But is that a fair characterization of the more important long-term trends? I think not. Consider that the same survey finds that total private sector employment has increased by 1.6 million so far this year. There's a lot of slippage in these numbers, and a lot of variation from month to month.

3) Relative to total private sector employment, the level of part-time employment has been declining (albeit irregularly) since the end of the last recession. The rise this year could be due to statistical noise, or it could be due to employers at firms with over 50 full-time employees reacting to the higher costs that will be imposed on them by Obamacare, and converting full-time employment into part-time employment to avoid the employer mandate. (I'm partial to the latter interpretation.) In any event, the recent rise in part-time employment this year is not likely symptomatic of any major, systematic, or sinister changes in the makeup of the U.S. labor force. We seen levels of part-time employment such as we have now several times in the past, and they usually follow recessions. This is nothing new or extraordinary.

Taking a dispassionate view from a longer-term perspective, the hue and cry over the recent rise in part-time employment seems way overdone. The more important truth is that the economy is generating almost 200K new private sector jobs per month, and most of the new jobs are likely full-time jobs. That's not a very stellar performance by historical standards—if this were a typical recovery we would have seem many millions more jobs created—but it's nothing to disparage.

UPDATE: Mark Perry provides some useful statistics which further explain this. And as he notes here, most of the increase in part-time employment came in just one month: March.

Q2 growth wasn't so weak after all

Thanks to strong growth in U.S. oil production, the U.S. is exporting more and importing less. With June trade data coming in stronger than expected (exports up $4.1 billion and imports down $5.8 billion), trade did not subtract 0.8 percentage points from second quarter growth as BEA estimated in last week's preliminary GDP report. If there are no other revisions, this would mean that growth in the second quarter will be revised to 2.5%, a good deal better than the first estimate of 1.7%.

Imports have been flat for the past few years, while exports have been moving slowly higher. This narrows the trade gap and adds to GDP.

Goods exports are now at a new all-time high and have more than doubled in the past decade.

Service sector surprises on the upside

Another day, another report showing the U.S. economy is not only avoiding a recession but in fact improving. Say what you will about the increased number of temporary, part-time, and low-paying jobs, it's still the case that conditions in the U.S. are slowly improving. That's a far cry from the recession fears that are still driving the Fed's zero interest rate policy and the public's seemingly insatiable demand for zero-interest safe assets. Today's service sector report is one more in a growing list of reasons why the U.S. economy no longer needs QE. The Fed could begin tapering its QE any day in my book, and it wouldn't much matter. Indeed, it might contribute to bolstering optimism in the future. At the very least, it is becoming abundantly clear—at least to me—that the U.S. economy is well beyond the stage at which it requires QE life support.

The July ISM service sector index handily beat expectations (56 vs. 53.1), and the business activity subindex (shown above) jumped from 51.7 to 60.4. That's quite a turnaround; perhaps there's some noise here, but at the very least it would appear that the service sector is on a solid footing and not even flirting with recession. 

No sign of deflation here: a clear majority of service sector businesses report paying higher prices.

The employment subindex continues to be moderately positive. We're not talking about leaps-and-bounds improvement, it's more a steady-as-she-goes economy that may be getting slightly stronger. 

As was the case with the ISM manufacturing report, the Eurozone service sector appears to be on the cusp of emerging from a two-year recession. This is good news for the rest of the world, which has been growing despite the Eurozone's struggles. 

The July UK service sector report was surprisingly robust, posting one of its strongest readings since the survey began in 2006.

Jobs: steady as she goes

The only remarkable thing about the July jobs report was its consistency. The trends that have been in place for the past several years—2% annual gains in private sector employment, a slow decline in public sector employment, very slow growth in the labor force, and a low labor force participation rate—all remain in place. Thus, we're left with an economy that is likely to continue to grow at a disappointingly slow pace. The Fed's Quantitative Easing strategy has yielded no meaningful change in the economy's ability to create jobs, but that is not surprising since there is no reason to think that it should. With the economy growing at a steady and unremarkable pace, and with systemic risk declining, there is little reason for the Fed not to begin to taper its bond purchases within the next several months. Bond purchases only serve to feed the world's appetite for safe-haven assets, and with each month that goes by with no signs of economic deterioration, that appetite is slowly but steadily ebbing.

Both surveys of the jobs market show the same thing: relatively steady private sector jobs growth for the past three and a half years.

The private sector has been generating new jobs at roughly a 2% annual pace for the past three years. That's almost exactly the rate of jobs growth that we saw in the years leading up to the Great Recession.

The decline in public sector employment has been welcome, since it had become bloated, but that decline shows increasing signs of coming to an end. The private sector is the source of most of the economy's growth, and it has been doing OK, but private sector employment is still below its pre-recession peak.

The labor force is still growing at a relatively slow pace, and it is significantly below its long-term trend. Many millions of workers have "dropped out" for a variety of reasons, and that is the source of the ongoing decline in the unemployment rate.

No signs of deflation in the dollar, gold, or commodities

The dollar is weak but improving on the margin, while gold prices and commodities are soft and declining on the margin, but still relatively high from an historical perspective. I think this points to a gradually improving outlook for the U.S. economy (e.g., double-dip inflation fears have now been replaced by a view that the economy can probably sustain modest growth of 2 or maybe 3%), and an ebbing of speculative pressures that had pushed gold and commodities to lofty levels. From a long-term perspective this is all positive. I don't see a reason to worry about deflation at this juncture.

The Fed's calculation of the dollar's inflation-adjusted value against a large basket of currencies and against major currencies is arguably the best measure of the dollar's effective strength vis a vis other currencies. As the chart above shows, as of the end of June the dollar was still quite weak from a long-term historical perspective, but it had risen on the margin in recent years.

Gold and commodities are in many ways the mirror image of the dollar's strength. Both reached very high levels from an historical perspective a few years ago, at the same time the dollar plunged to new all-time lows. Since then, gold has declined and commodity prices have eased, at the same time the dollar has recovered a bit.

The chart above shows the CRB Spot Commodity Index, arguably the best measure of non-energy, non-gold commodity prices, and its 5-year moving average (purple line). Although commodity prices are down from their 2011 highs, they are still above their 5-yr moving average. I show this on the theory that it takes perhaps 5 years for the world to adjust to commodity prices, so any important deviations from the 5-yr average creates problems, either for producers (unexpectedly weak prices) or consumers (unexpectedly strong prices). I note that the last time the U.S. came perilously close to a general deflation was in the late 1990s and early 2000s, and that happened to be a period during which commodity prices were exceptionally weak, both historically and relative to their 5-yr moving average. That's not the case today, so I think that argues against the risk of deflation.

As above chart shows, 5-yr TIPS and Treasury yields are priced to the expectation that inflation over the next 5 years will average about 2%. That is substantially higher than expected inflation was back in the late 1990s and early 2000s, and it is very close to the 2.1% average we have seen since TIPS were first introduced in 1997. In other words, there are no signs of deflation fears in the bond market.

The most likely explanation for what is happening to gold and commodity prices is that they are coming off of speculation-induced highs, not that they are now signaling deflation risk. An ebbing of speculative pressures such as these actually augurs well for the long-term outlook for the economy, since it means that investment decisions are increasingly based not on speculation, but on the economic merits of each decision.

A decent manufacturing report trumps QE

A much stronger-than-expected manufacturing report (54.5 vs. 52) from the Institute for Supply Management, indicating that U.S. manufacturing activity in July was picking up, has proved once again that the perceived health of the economy is a more powerful determinant of interest rates than the Fed's monthly purchases of $85 worth of Treasuries and MBS. 10-yr Treasury yields are now over 100 bps higher than they were when the Fed initiated its QE3 campaign almost a year ago—in which time it has purchased enough bonds to finance the entire federal deficit—because the market now sees that the economy is on a stronger footing, even though expectations for growth remain very unimpressive. A year ago the market thought the U.S. economy faced a serious risk of many years of dismal growth or even another recession; today the market likely believes that the economy can sustain growth of 2-3%, a rate of growth that would still qualify this recovery as being the weakest ever.

This is a very important assertion, since it casts serious doubt on the assumption that many observers have made that the Fed has been artificially lowering interest rates and in the process distorting the capital markets and artificially stimulating the economy. As I've asserted for a long time, the Fed's QE program has been designed not to stimulate the economy but to accommodate the world's intense demand for money and cash equivalents. And not only has monetary policy not been stimulative, but fiscal policy has been acting like a headwind to growth, since its emphasis has been on redistribution, huge new regulatory burdens (e.g., Dodd-Frank, Obamacare), and higher taxes. In short, what we are seeing is that the economy has been growing in spite of monetary and fiscal policy, not because of it. The recovery, as meager as it has been, is nevertheless a genuine recovery which could be much stronger if fiscal policy were to get out of the way of the private sector. Which it in fact is, though much remains to be done for the outlook to brighten significantly.

  

As the chart above shows, the July level of the ISM manufacturing report is consistent with GDP growth of 3-4%, which is substantially better than what we have seen over the past year or so.

The export orders subcomponent of the ISM index suggests that overseas economies continue to expand. If the world is increasing its purchases of U.S. goods, that helps sustain our growth.

The prices paid index continues to point to little or no inflationary pressures, confirming that monetary policy has not been stimulative—it's simply been accommodative of strong demand for money.

The employment index last quarter had dipped to zero-growth levels, but has now rebounded, suggesting that manufacturers feel more optimistic about the future.

Although the Eurozone has yet to pull out of its two-year recession, manufacturing activity is no longer contracting, as suggested by the July Markit survey of manufacturing. It would appear from this chart that both the U.S. and the Eurozone are enjoying a modicum of improving conditions. 

The ongoing rise in global equity markets is thus supported by an improving economic outlook. Very good news, even though global equities have yet to regain their former highs set almost six years ago.