Jobs growth has been one of the strongest data points on the US economy, although we are now questioning whether the weakness seen in the recent data points, particularly the manufacturing sector, is starting to spread to other areas of the economy. This has been evident in broad based indicators such as the Chicago Fed National Activity Index, a composite of 85 monthly indicators where a positive/negative reading corresponds to growth above/below trend, which has remained weak with the December reading at -0.22 and the prior reading revised down to -0.36. While it is not yet at levels indicating a recession it suggests this risk is rising. Even the services sector has started to show some signs of slowdown; earlier this week the January ISM non-manufacturing fell to 52.1 which was the weakest reading since February 2014.
Today’s non-farm payroll data for January painted a mixed picture showing 151,000 jobs added, which was below expectations of 190,000 jobs added and compares with a revised 262,000 jobs added in December. But the average ‘jobs added’ over two months was 206,500 which is still at a level the Fed is likely to consider ‘acceptable’. The unemployment rate edged down to 4.9% and the participation rate edged up to 62.7% from 62.6%. Average hourly earnings picked up to 2.5% yoy against expectations of a 2.2% yoy increase and average hours worked increased to 34.6 from 34.5 in December.
The January Fed statement noted “the Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.” This more dovish tone, and a slew of weak data points, had pushed down Fed futures implied probability for a rate hike in March to only 10% ahead of today’s data from 50.8% at the start 2016. Today’s data release was inconclusive; as ever a Fed tightening in March will remain data dependent but it looks unlikely at this stage. William Dudley, President of the New York Fed, noted in an interview this week "financial conditions are considerably tighter than they were at the time of the December meeting. So if those financial conditions were to remain in place by the time we get to the March meeting, we would have to take that into consideration in terms of that monetary policy decision."
The situation is complicated by the Fed trying to reverse policy when growth in the rest of the world is weak and central banks elsewhere are resorting more and more to the use of negative interest rates. Most recently, the Bank of Japan resorted to negative interest rates of -0.1%, albeit on excess reserves held at the central bank, but it also signalled it would cut the rate further if it judged it to be necessary. The ECB has been trying this policy tool since 2014 and increased the negative rates to -0.3% in December 2015; it is now expected to do more in March after Mario Draghi took a dovish stance at January’s ECB press conference stating “downside risks have increased again” and “in this environment, euro area inflation dynamics also continue to be weaker than expected. It will therefore be necessary to review and possibly reconsider our monetary policy stance at our next meeting in early March.”
In the tightening cycles of 1994 and 2004 the dollar appreciated more ahead of the initial rate rise then weakened in over the next six months and over the next two years remained below the level it started the cycle at. Until this week the dollar index has remained strong; this had been exacerbating the problem for central banks adding to the tightening effect of the Fed rate rise in December and a strong dollar is negative for commodity prices and had been adding to deflationary pressures. But the dollar reversal in recent days has provided a bit of a reprieve.
In a situation where global aggregate demand is weak the risk is central bank easing becomes a game of competitive devaluation with no real winner; the danger is that QE is seemingly having better success in promoting risk taking in financial markets rather than stimulating growth in the wider economy as evidenced by the declining velocity of money. QE is ultimately deflationary and the two lost decades experienced by Japan could well provide the best blueprint for the direction of bond yields.