"Kee" Points with Jim Kee, Ph.D.

Market data indicates that the US GDP has accelerated from the low first quarter, but probably not by much. That combined with last Friday’s very weak jobs report certainly lessens the chance of a Fed rate hike this summer. Nonfarm Payroll employment increased by just 38,000 in May, or 73,000 if you adjust for 35,000 striking Verizon workers (Capital Economics). That’s a big negative surprise, as the consensus forecast was for about 160,000. Of course, monthly numbers are volatile, and the prior three month average is the most relevant number for anticipating future jobs numbers. That number is 115,000, but the declining trend is a little disconcerting (186,000 in March, 123,000 in April, and now 38,000 in May).


During our client updates at the beginning of the year I discussed how during the Great Recession the decline in payrolls was greater relative to the decline in GDP than any time since the Great Depression of the 1930s; companies were unsustainably lean. So some of the job growth during the current expansion has been more of a normalizing phenomenon. In fact, whereas GDP is about 25% above its 2008 peak level, payroll employment is only about 4% above its prior peak. Given an economy growing at half the normal 4% expansion average, it makes sense to me that employment growth would slow as it converges to a rate consistent with mediocre GDP growth and as the unemployment rate falls to historic norms (albeit with a falling labor participation rate). But that decelerating monthly trend in job growth is certainly worth keeping an eye on, and I do. In fact, today Fed Chair Janet Yellen mentioned this jobs report, weak business investment spending, and weak overseas growth as areas of concern, although she felt that the positives in the US economy (e.g. positive housing market data, consumer spending, increased household wealth and wages) outweighed these negatives. That leads her to be “cautiously optimistic.”


Jeanie Wyatt and I were at a Federal Reserve Bank of Dallas San Antonio branch lunch last week with a lot of local business leaders. A very consistent theme was the growing regulatory burden, from compliance with the Dodd-Frank Act (banking and financial institutions) to the jaw-dropping increases in employee health care costs (50%-70% increases cited by several employment firms). I’ve mentioned before that regulatory (and tax) complexity and uncertainty has increased fairly dramatically, so it is not a huge surprise that economic growth is sub-par. As an economist, it would be perplexing to have these increased burdens along with robust growth!


Anyway, I think a key takeaway from the jobs report is how bad the consensus (of experts) is at forecasting. That’s consistent with the simple “plucking model” of the economy which holds that downturns are caused by various more or less random economic shocks, which are usually out of the blue and cannot be forecasted. But the impact of current and prior shocks can be discerned by watching the data closely, and some of the better economic nowcasting models do that (the Atlanta Fed’s model updates on Thursday). It is important to remember that the weaker the economy, the higher the chance that any given shock causes a slowdown or recession. Actually, since the 1970s a lot of so called forecasting has really devolved into mere extrapolation of prior trends in aggregated data or aggregates. That’s how you get a consensus forecast of 160,000 payroll jobs when the actual number is less than half of that. Nobel Laureate Frederick Hayek used to point out (warn, really) that “Statistical variables such as national income, investment, price levels, and production are variables that play no role in the process of their determination itself.” Hayek’s point was that economists and analysts who focus on aggregates without understanding the underlying incentives at the level of the individual-whose behavior produced those aggregates-will have a very superficial view of the economic landscape. I have always found this to be one of the more profound statements in macroeconomics.


Finally, oil seems to be holding steady near the $50/barrel mark, and that continues to be positive for markets. But we don’t expect to see a big increase in Energy sector capital spending any time soon. Like most firms, energy companies plan their hiring and capital spending decisions based upon future expectations, and those usually involve best and worst case scenarios. As mentioned in prior Kee Points, it is one thing to estimate a worst case scenario of $20-$30 oil as a hypothetical. It is quite another thing to make that estimate in light of having just watched it occur (like now)…the worst case scenario becomes more real, and a higher probability is attached to it. That means more caution on the part of energy companies with respect to capital spending going forward.