The Risks in the February Employment Report And More

The  markets are viewing the current softening in economic activity as temporary.   As a result, stocks are rebounding and longer-term Treasury yields are edging up.  The biggest risk to this situation is if inflation ratchets up or, to a lesser extent, if real growth speeds up.  Higher inflation would spark fears of renewed Fed tightening, boosting Treasury yields further and hurting stocks.  Stronger real growth without higher inflation would lift Treasury yields somewhat, but would not necessarily precipitate Fed tightening.  So, it would be a positive for stocks.  This week's February Employment Report contains some elements that could add to inflation concerns but is expected to show signs of the current softening in real growth. 

The biggest inflationary risk in the Report is Average Hourly Earnings.  Calendar considerations support the consensus expectation for a speedup to +0.3% m/m from +0.1% in January.  The y/y would return to its recent high of 3.3%, with a 3.4% print if the m/m rounds down from 0.32%.

The other inflationary risk is for a decline in the Unemployment Rate from January's 4.0%,  although there is mixed evidence.  Consensus looks for a drop to 3.8%, possibly based on the idea that people who lost their jobs indirectly because of the government shutdown are back to work.  Or, the increase in the Rate over December-January was attributable to an increase in the Labor Force Participation Rate.  If the latter catches up to the slowdown apparent in other economic data in those months and falls back, the Unemployment Rate would likely fall.  However, the Claims data suggest a flat to higher Rate in February.  Also, the rebound in the Conference Board Consumer Confidence Job Components suggests the Participation Rate could stay high if not rise further.  So, the risk is that Rate prints higher than consensus.

The Claims data also suggest a slowdown in Payroll growth, and may very well be behind the consensus estimate of +170k m/m versus +304k in January.  There could be other reasons, as well.  Payback for the mild January weather would help explain slower job growth.  Also, the latter could be a lagged effect of the weaker economic growth in December-January.

Questions Re Trump/China Negotiations
Trump's walking away from the Kim Jong-un summit raises some questions regarding the US/China negotiations:

1. Will Trump walk away from the US/China negotiations if it looks that he will not get everything he wants?

2.  Does the walkaway from North Korea send a warning to Xi Jinping that Trump will end their negotiations if China doesn't capitulate to all the US demands?  Does such a warning increase or decrease the probability of an agreement?

3.  Does the walkaway make Trump even more anxious for an agreement with China?

4.  Will these concerns begin to filter into the markets?

Nobody knows the answers.  But, they're worth keeping in mind until proved inconsequential.

Comments on Last Week's US Economic Data -- Posted to Twitter (@cjslyce) and Linkedin.

Friday:

The most important data today is probably the Michigan Consumer Sentiment's 5-Year Inflation Expectations. It dropped to 2.3% from 2.6%, putting it back to a low. Fed officials are alert to long-term inflation expectations, so at the minimum the drop supports their patience.

Today's other data were soft, but could be temporary. The decline in the Feb Mfg ISM to 54.2 from 56.6 could be partly catch-up after it bounced in January. The 55.0 3-month avg, however, confirms a modest slowdown in mfg.

Thursday:

The 2.6% q/q Q418 Real GDP not only came in stronger than consensus (should have raised their estimates after yesterday's data) but also the Fed's estimate. Powell's testimony said Fed staff looked for slightly below 3.0% Q4/Q4 GDP Growth in 2018. Instead, it came in at 3.1%. 

The Q418 GDP composition suggests a further 2-3% increase in Q119. There were solid gains in Consumption and Equipment Spending. Inventory Investment rose to a high level, consistent with the unexpected drop in Dec Sales. But, Inventories and Sales should reverse in Q119.

The Q418 GDP Price Indexes should keep inflation on the radar screen for the Fed, even though some are below the 2.0% target. The Core GDP and PCE Deflator both edged up -- to 2.0% (q/q) and 1.7%, respectively. The Market-Based Core PCE Deflator jumped to 1.5% from 1.2%.

The Claims data were somewhat on the high side, but they were for the week containing Presidents Day. Holiday weeks are difficult to seasonally adjust. So we have to wait to next week's report to see whether they stay up.

Wednesday:
Final Street and Atlanta Fed model estimates of Q418 Real GDP risk being raised after today's advance data on Dec Retail, Wholesale Inventories and Trade Deficit. Much of the wider TD looks to be offset by higher Business Investment. Inventories bounced.