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September 7, 2007
Nonfarm payrolls fall for first time since 2003
Not good. Nonfarm payrolls fell by 4000 workers--given that revisions can be substantially larger than this, we can just say that it is flat. And flat is not good at all.
Here's something out of the report that highlights the even softer underbelly of this already soft report:
The number of persons employed part time for economic reasons, at 4.5 million in August, was 359,000 higher than a year earlier. This category includes persons who indicated that they would like to work full time but were working part time because their hours had been cut back or because they were unable to find full-time jobs.
That's roughly an 8% jump in the number of people employed part time for economic reasons since last year. Hard to put a positive spin on that.
As usual, PGL at Angry Bear reports on the employment to population ratio and the labor force participation rate.
How does this affect the outlook for the FOMC meeting? Glad you asked. The CBOT binary options now put a 93% probability on at least a 25 basis point cut and now a 60% probability on at least a 50 basis point cut.
The market is now firmly, solidly, and perhaps irrevocably convinced.
And it is hard to argue with it. All along this path, I have argued that it would take genuine weakness in the economy to push the Fed off its trajectory. As we went through spring and summer many observers, myself included, became more convinced that the strong 2nd quarter GDP figures may be the last gasp before significantly slower growth in the 3rd and 4th quarter. Recession probabilities are higher. Given that the labor market is lags the overall economy slightly, it is possible that in hindsight we will look back and say that at this point a recession had already begun. While I still think it is premature to make that call, it would be wrong to ignore the possibility.
Just in case you don't have enough to worry about already, listen to what Michael Mandel has to say.
If you are worrying about the economy, don't start with the weak job report--start with yesterday's productivity report. Nonfarm productivity has only risen by 0.9% over the past year. The four-quarter average of nonfarm productivity has only risen by 0.5%, the smallest increase since 1995.
Productivity growth establishes the sustainable growth rate of the economy. The fact that productivity growth is so slow has two consequences. One, it means that the economy is much more vulnerable to shocks that can push it into recession. Second, it puts Bernanke into a bind...with productivity slow, he has to be much more worried about inflation.
It is the latter consequence, the inflation threat, which weighs over Chairman Bernanke's head as they go into the meeting. While it is unlikely that a single rate cut this month would significantly increase inflation, the Fed needs to be very careful about what they communicate about where they will go from here. In 1998, the Fed cut three times and didn't remove the accommodation for almost a year. Some say that contributed to the end game of the bubble and bust of the dot coms in 1999 and 2000. An analysis of that episode and its lessons for today could spawn many essays.
And so we go into this weekend under the expectation that a rate cut on the 18th is almost a foregone conclusion. And that means it's time to start thinking seriously about October, which is not a foregone conclusion yet. We'll see a lot of data between now and then. Lots of things to think about.
For the 18th, a 25 basis point cut with the risks weighted equally towards lower growth and higher inflation would acknowledge what is happening without locking them into anything for the next meeting. It is imperative that they not lock themselves into anything for October. I have less objection to a 25 basis point cut if it is understood that it is NOT the first in a sequence. If it is interpreted as the first in a sequence, that will only lead to problems later.
Posted by William Polley at September 7, 2007 2:51 PM
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Comments
Seems to me, if the Fed cuts 25 bps, after the report we just had, nobody's going to believe that's the last one. Maybe it would make more sense to cut 50 bps and issue a statement along the lines of "We hope and believe that this will be more than sufficient to neutralize any effect the financial crisis will have on the real economy." That has a sense of finality, but it also leaves the door open for more cuts if they later decide that the real economy was in worse shape to begin with.
Regarding productivity, the reports would bother me a lot more if we didn't have a weak economy. Though by now I'm a bit troubled about productivity, it still seems that most of the recent slowing is a cyclical effect. We've had a year over which businesses have been uncertain as to whether they needed to cut employment, so they've been producing less (relative to trend) but not yet trimming employment. By definition, that means less productivity. (I would note in particular the failure of construction employment to decline materially until recently.) Right now it looks like the next step is to reduce employment, which may make productivity grow a bit faster, as functionally redundant workers are eliminated. Alternatively (though it now seems rather unlikely), we could have a recovery and make those functionally redundant workers useful again, and productivity would rise that way also.
Posted by: knzn at September 7, 2007 4:35 PM
"Seems to me, if the Fed cuts 25 bps, after the report we just had, nobody's going to believe that's the last one."
That thought crossed my mind as well. The Fed has just not yet found the way to communicate the future trajectory of interest rates in the sterile language of the press release. The ECB approach of having a press conference would have a better chance perhaps.
The scarier thought to me is what if they cut 50 b.p. (which gives it too much juice, in my opinion given what we know now) and the market doesn't get the message that it's a one-and-done either. That's worse.
As for productivity, you could be right. But at the moment, we really don't know if this is cyclical or secular. When the productivity slowdown hit in the 1970s the Fed didn't recognize that it was a break in the trend. And while I'm not suggesting that was the only thing at play in the Great Inflation, it was a factor. It probably wouldn't be as bad today, but even if it pushed the core rate back up to 3-4%, for example, Mr. Bernanke would have some explaining to do. How much is he willing to bet that you're right?
Posted by: William Polley at September 7, 2007 11:19 PM
The productivity report seemed better than this analysis implies. Late last year productivity weakened sharply and unit labor cost was rising faster than prices with the logical squeezing of profit margins. But in the first half of the year productivity improved and unit labor cost gains slowed significantly so they were growing slower than prices and profit margins improved. While the productivity situation is not good, looking at the year-over-year gains versus developments in the last two quarters makes the situation look worse then it may be.
But anyway, productivity is a great leading indicator and it implies that at best the recent sub-par or below trend growth will continue.
The Fed itself does not know what they will do later in the year. So how can they convey to the markets something they do not even know themselves. We do have to live with a high level of uncertainty -- that's life.
Posted by: spencer at September 8, 2007 10:47 AM
"The Fed itself does not know what they will do later in the year. So how can they convey to the markets something they do not even know themselves."
That's my point! I say again that it is imperative that they not issue a statement that locks themselves into something in October. Knzn's comment suggests that this might be easier said than done given the market's recent tendency to take a little bit of information and run.
Of course they don't know. So I don't want them to give the market anything that they can run with and think that they do know. This is a very real concern.
Instead of "Remember the Alamo!" our cry should be "Remember 'measured pace'!"
Posted by: William Polley at September 8, 2007 11:09 AM
I don't think 50 bp is too much juice, but I think I'll save the reasons for the next post on my own blog, because it's already more than a page long.
Posted by: knzn at September 8, 2007 4:37 PM