September Jobs Prints 'Fair' But Is Ameliorated By Revisions; Geopolitical Concerns And A More Hawkish Fed Concern Us

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by: J.G. Collins

Summary

July and August revisions offset an otherwise disappointing jobs report.

Russia's efforts to reprice oil away from USD might threaten America's "exorbitant privilege" as the world's reserve currency.

A more hawkish Fed challenges lesser developed economies. For example, the INR is trading at a record low versus the USD, challenging India's liquidity.

Developing nations' liquidity issues are likely to lead to write-offs or restructurings of debts owed to major international banks.

NEW YORK (October 5, 2018) - The September jobs report printed well below forecast, at 134,000 new jobs. The consensus estimate had been 51,000 jobs more, at 185,000. Nevertheless, the significant upward revisions to the July (+18,000 jobs) and August (+69,000 jobs) numbers tend to soften the otherwise disappointing results. The revisions resulted in average three months' job creation of 213,000, jobs and six months' average jobs creation of 206,000.

The unemployment rate was 3.7 percent, down 2/10ths of a percentage point from August and down 0.5 percentage points from the same period last year. The labor participation rate was flat at 62.7 percent from August to September, but down 3/10th of a percentage point from September 2017. The U-6 Unemployment, at 7.5 percent, was up 0.1 percentage points from July but down 4/5ths of a percentage points from July 2017. It is a low U-6 number relative to most recent history.

Analysis: Detail and Outlook

September job gains were spread over a few occupational sectors: Financial activities (+1,000); Manufacturing, durable and nondurable goods (+13,000); and Transportation and warehousing (+2,500). Jobs were lost in the low wage occupations of retail, hospitality, and other services. All other occupational sectors created fewer jobs than in August.

Nominal average weekly wages increased by 3.35 percent year on year at a rate that is higher than inflation, as illustrated in our quarterly analysis of wages:

We're both surprised and a bit concerned, though, that manufacturing wages have declined.

Overall, this was a just a fair jobs report, but that’s offset by the increase in average weekly wages. Moreover, the revisions for July, July and August caused the 3-month and 6-month average jobs creation to bump up to 200,000 jobs again.

We anticipate 2018Q3 to print in the range from 2.7 to 3.2 percent.

Let's look at our exclusive jobs creation by average weekly wages for the June jobs report:

0918 Jobs Creation by Average Weekly Wages

September Jobs Creation by Average Weekly Wage; Source: The Stuyvesant Square Consultancy, compiled from BLS Establishment Data for September, 2018.

The number employed increased by about 420,000 people, and about 150,000 more joined the workforce. The JOLTS survey for July, the latest available data, showed 117,000 new job openings from June to July but up 642,000 jobs from July 2017.

Oil Pricing and Geopolitical Concerns

We're heartened to see average gasoline prices continuing below the $3 per gallon threshold. Gasoline prices remain higher than last year but seem to have plateaued, with September prices just 5.5 percent higher than last year, compared to a 16.8 percent year-on-year increase in August. We fear rising oil prices are likely to push gasoline prices higher, reducing disposable income and reducing critical consumer demand.
With further respect to oil, our concerns over the last few months with Iraq’s deteriorating domestic political situation have been somewhat allayed from last month’s jobs report with the election last week of Iraq’s new consensus secularist leaders as president and prime minister. Both men are respected by the United States and Iran, so we cautiously aver that the Iraq will stabilize in the next year or two.

Our concerns were with respect to Iraq’s exports of oil to developing economies, particularly India and China, which import about 15 percent and around 9 percent of their oil from Iraq, respectively. Other big importers of Iraqi oil include Italy. That said, we’re still concerned about Iran’s belligerent rhetoric and the tightening noose of sanctions the US is imposing against Iran. We continue to fear it could precipitate some unforeseen flash point in the region. Iran’s leadership has said that they would cease all flow of oil through the Straits of Hormuz if Iran could not sell oil because of U.S. sanctions.

The U.S. Navy quietly deployed the Essex Amphibious Ready Group (click here to see the sample makeup of an ARG) in July. It is now in the Gulf of Aden, within a day or two’s steaming to the Straits of Hormuz. The Essex ARG has a contingent of VSTOL (i.e., Harrier) aircraft and Marine expeditionary forces. As currently deployed, the Essex ARG can deter Iranian adventurism in the straits without precipitating an outright threat to Iran's leaders.

Finally, with respect to oil, we are concerned that Russia’s stated objective, as retaliation for US sanctions over Russia’s annexation of Crimea, is to de-dollarize its currency reserves and to reprice global oil without reference to the dollar. A similar statement to move from the dollar as the world’s reserve currency - by a newly minted, and largely under-briefed, Treasury Secretary Tim Geithner early in the Obama Administration - was quickly “clarified” after it sent markets and the dollar plummeting.

Dollar-Denominated Debt

Corollary to our concerns about oil was and is our concerns that higher rates and a stronger dollar impinge developing nations' ability to repay dollar- and euro-denominated debt they owe to American and European banks. Notably this week, the Indian rupee was recorded at new record lows vis a vis the dollar.

When the Fed and the ECB were dovish, foreign countries stepped up their foreign-denominated debt at an enormous rate. Now that developed economies are normalizing and their currencies strengthening, there will be enormous pressure on developing nations to raise rates to keep their currencies at relative parity with the dollar and the euro, which will, in turn, slow those economies. The alternative is to let developing nations’ economies inflate, which will have the same effect. (This is why we continue to be circumspect about normalizing rates too quickly; it threatens the economic health and well-being of developing economies and puts additional pressure on the already struggling PIGS in the eurozone. That, in turns, translates to risk for large international banks.)

Other Macro Data

July freight flows data increased substantially year on year, and was also up from June.

We're also heartened that people are taking home more cash from the tax cut, so that debt service will account for a lesser percentage of disposable income. Data released early last month for 2018Q2 continued to support the thesis we expected since the tax bill passed.
We note these other developments since our last jobs report:

  • The wholesale trade report for July, reported September 11th, showed sales up 9.8 percent year on year and inventories up 5.0 percent from last year. The inventory to sales ratio was 1.26 percent, from 1.32 a year prior.

  • Building permits for August, released September 19th, declined, by 5.7 percent month to month and 5.5 percent year on year. Housing starts were up 9.2 percent month to month and up 9.9 percent year on year.

  • The ISM Manufacturing report for August, released October 3rd, showed continuing but declining expansion of manufacturing, down from July’s 59.8. The ISM Non-manufacturing report, also for June and released this morning, printed at 61.6, also up from August’s 58.5.

  • Personal Income & Outlays for August, released September 28th, showed disposable income increased by 0.3 percent in current dollars, unchanged since July. It was unchanged in chained 2012 dollars. Personal consumption expenditures (PCE) decreased 0.1 percent from last month at 0.3 percent. They were also down 0.1 percent from July in constant dollars.

  • The IBD/TIPP Economic Optimism Index for September slipped to a still healthy 55.7, down from the August 14 year high of 58 (anything above 50 indicates growth.) The October index should be released Monday.

Fed Normalizing

As stated above, we are concerned about moving rates too much higher. While inflation for personal consumption expenditures, less food and energy, or "Real PCE", has hit the Fed's target of 2 percent, we continue to believe that moves toward normalization should take place more slowly and only after growth has become decidedly more robust over several more quarters; at least four quarters of consistent quarter on quarter 3.5 percent GDP growth. (As we have illustrated, the 2018Q2 GDP figure included a lot of "shifting" from and to earlier or later quarters.)

We have long held the view that trimmed mean PCE, produced by the Dallas Fed, is a better measure of inflation in the day-to-day costs of most Americans. It is currently at 2 percent. The 2.25 percent rate the Fed has adopted, if increased substantially, together with anticipated rate increases, will stifle GDP growth and damage developing economies.

Largely tied to that, we continue to be troubled by the yield curve, as we have discussed repeatedly. The 3-month/10-year curve that we most closely monitor has improved from last month, when it was just 75 bps, but the spread is still now just 100 bps. At the beginning of 2017, it was nearly 200 bps.

We believe the flat, albeit improving, yield curve is yet another sign that Fed rate hikes are premature and are outpacing the economy's growth. (The Fed mostly affects short-term rates, principally the 3-month, hence our using that and the 10-year, versus the 2-year/10-year curve used by most.)

While we are encouraged that the 10-year rate is driving the spread between the two, we think that that increase should allow some running room; it should go at least 150 bps above the 3-month short-term rate before the Fed considers another rate increase.

That higher 150 bps spread from the current 2.25 percent 3-month rate would evidence a more holistic appetite for increased risk, as signaled by moving away from Treasuries and into “risk-on” assets.

While we dogmatically prefer a strong dollar from a high demand for US goods and services, we're wary of dollar strength arising from the Fed's interest rate hikes more than robust demand for U.S. goods and services.

We remain unperturbed by the trade dispute with China and by the Trump tariffs. We support the president's more diligent management of trade to defend against cheating and to oppose tariff and non-tariff barriers. Nevertheless, we would like to see the president engage America’s Asian and European allies to step up to join a "coalition of the willing" to challenge China's decades-old unfair trade practices and thefts of intellectual property because a one-on-one dispute will simply trigger mutual retaliation. There is more power among a multilateral “we” than a unilateral “us”.

While CEOs seem concerned about margins if China manufacturing sites are lost in a trade war, we note that contract producers in most businesses are available in other locations and at lower wages than China, and that thefts of intellectual property present a longer-term threat to US businesses. We are bullish on India, notwithstanding the current low value of the INR, and believe it is a much more promising venue for low-wage manufacturing investment over the long term; however, again, the Fed aggressive rate increases risk a “sudden stop”.

In our view, China can't afford a restless - or even a rebellious - populace being unemployed. Its leaders need exports to the U.S. and Europe more than the West needs access to China’s markets. Losing American sales from Chinese markets might hurt American and European companies' bottom line and anger American farmers, but losing Chinese jobs to American tariffs might collapse China’s government. We’re circumspect about the rate of GDP growth reflected by the slightly revised 4.2 percent reported for 2018Q2. We continue to believe it arose largely from stacking up GDP from prior and later quarters, as discussed here.

We hope that today’s jobs number will forestall the Fed’s reported pace of rate increases. We’re inclined to predict the Fed may elect to “stand pat” at its December meeting because we think the September increase will slow the economy and continue to slow the rate of job growth. We also think it will pressure the earnings of large commercial banks with large developing nation and southern European loan portfolios.
We estimate 2018Q3 GDP will print at 2.7 to 3.2 percent, up slightly from last month. In equities, we think these sectors will perform as follows:

  • Outperform: Consumer discretionaries in the mid- to high-end retail sector; certain leisure and hospitality, trucking on speculation of consolidation and acquisition; the asset-light hospitality sector on speculation of increasing franchisee property values and higher room rental costs, and companies or REITs that own real estate in sectors identified as “opportunity zones” under the Tax Cut and Jobs Creation Act of 2017.

  • Perform: Consumer staples, energy, utilities, telecom, and materials and industrials.

  • Underperform: Lower-end consumer discretionaries, like dollar stores; healthcare; financials; and technology.

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