Employment growth is still too hot, even for this economy

Chief Economist Eugenio J. Alemán discusses current economic conditions.

The U.S. economy grew at a more than expected 2.0% annualized rate of growth during the first quarter of the year compared to the previous quarter. In some sense, this rate of economic growth makes a little bit more sense than the previously reported 1.3% rate estimated during the previous BEA release. This is because employment growth has continued to outpace even this higher rate of economic growth.

As we wrote in our June 9, 2023, weekly publication, Thoughts of The Week, the labor market has been too hot during the first five months of the year and is bound to slow down considerably during the second half of the year. Within that publication, we mentioned that several sectors had already created more jobs in five months this year than what had been created for the whole of 2019, which was just before the COVID-19 pandemic and when the U.S. economy posted a growth rate of 2.2% for the whole year. Other sectors were close to creating a similar number of jobs in five months in 2023 than had created in 2019 while there were other sectors that were lagging.

However, overall, the U.S. economy has created 80% of the jobs created in 2019 so far in the first five months of 2023, at a time when we are still expecting GDP growth to come in below the growth rate experienced in 2019 for the whole year. This is the reason why we expect employment to slow down considerably during the second half of this year and one of the reasons why we are still calling for a recession starting in the last quarter of the year.

The second half of the year is going to be all about consumption (…and inflation)

The second half of the year is going to be about the U.S. consumer. Although consumption was very strong during the first quarter of the year, we are starting to see weakness on the horizon as pandemic excess savings continue to be depleted and millions of Americans that have not been paying student loans for several years have to repurpose their current incomes in order to start paying those loans once again.

Furthermore, we continue to watch credit card borrowing, which has been growing too fast and is probably one of the Federal Reserve’s (Fed) biggest concerns today, to see if the current increase in interest rates is enough to slow it down. If not, the Fed is ready to continue to increase the federal funds rate in order to further slow credit card borrowing.

However, not all is bad news for the U.S. consumer as employment continues to remain strong and real disposable personal income continues to increase for two reasons: first, because employment continues to increase and, second, because inflation continues to come down on a year-over-year basis, that is, the disinflationary process is still alive and well.

Thus, as long as employment stays strong, consumers are going to keep on consuming because they will remain positive about their income prospects into the future. However, at the first signs of weakness in employment, the prospects for economic growth are going to start to change.

For now, the consumer remains strategic in their consumption patterns, i.e., increasing consumption in one month and then slowing down consumption the following months. During the first quarter of the year, all consumption occurred in the first month of the year as real personal consumption expenditures remained flat in February and March. In April, real personal consumption expenditures increased but then remained flat in May. If we don’t have a recovery in real personal consumption expenditures in June, growth in the second quarter of the year is probably going to be very weak.

The reason for this is that, during the first quarter of the year, real PCE contributed 2.79 percentage points to economic growth while real gross private domestic investment subtracted 2.22 percentage points from growth. Thus, a weaker contribution from PCE at a time when interest rates are keeping real investment from making a positive contribution to GDP growth could make the prospects for growth in the second quarter of the year very challenging.

We still believe that individuals will consume a bit more in June and consumption’s contribution will remain positive and be enough to counteract investment’s negative contribution, but we will probably need net exports as well as government expenditures to help during the second quarter of the year.

In conclusion, the U.S. economy continues to grow but growth will continue to weaken during the second half of the year.

Goods versus services inflation

Consumption during and after the COVID-19 pandemic was driven by the goods sector of the economy as consumers remained home while supply chain issues put even more pressure on goods prices. Thus, the price index for goods surged at a faster pace than services prices. However, goods prices have been coming down very quickly during the last year or so while services prices are still increasing on a 12-month-moving average basis, as we can see in the graph below.

The service side of the economy is what has kept the Fed on the defensive during this year and why it is still calling for at least one more rate increase and at most two rate increases before the end of this year.

There are two sectors that are of concern for the Fed today. One is housing services and the other one is transportation services. As the graph below shows, transportation services prices have started to turn the corner on a 12-month-moving-average basis. However, housing and utilities services are still going up.

We believe that housing and utilities services prices are going to start moving down very soon and relatively rapidly, but the Fed remains concerned with the overall effect of these services on inflation and would rather err on the side of caution. That is why we still believe that the Fed is going to increase the federal funds rate once more this year, perhaps after the September FOMC meeting.

Economic and market conditions are subject to change.

Opinions are those of Investment Strategy and not necessarily those of Raymond James and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur. Last performance may not be indicative of future results.

Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.

Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.

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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.

The Conference Board Leading Economic Index: Intended to forecast future economic activity, it is calculated from the values of ten key variables.

The Conference Board Coincident Economic Index: An index published by the Conference Board that provides a broad-based measurement of current economic conditions.

The Conference Board lagging Economic Index: an index published monthly by the Conference Board, used to confirm and assess the direction of the economy's movements over recent months.

The U.S. Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The Index goes up when the U.S. dollar gains "strength" when compared to other currencies.

The FHFA House Price Index (FHFA HPI®) is a comprehensive collection of public, freely available house price indexes that measure changes in single-family home values based on data from all 50 states and over 400 American cities that extend back to the mid-1970s.

Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).

ISM New Orders Index: ISM New Order Index shows the number of new orders from customers of manufacturing firms reported by survey respondents compared to the previous month. ISM Employment Index: The ISM Manufacturing Employment Index is a component of the Manufacturing Purchasing Managers Index and reflects employment changes from industrial companies.

ISM Inventories Index: The ISM manufacturing index is a composite index that gives equal weighting to new orders, production, employment, supplier deliveries, and inventories.

ISM Production Index: The ISM manufacturing index or PMI measures the change in production levels across the U.S. economy from month to month.

ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.

Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households. Changes in measured CPI track changes in prices over time.

Producer Price Index: A producer price index (PPI) is a price index that measures the average changes in prices received by domestic producers for their output.

Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.

The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index measures the change in the value of the U.S. residential housing market by tracking the purchase prices of single-family homes.

The S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index seeks to measures the value of residential real estate in 20 major U.S. metropolitan.

Source: FactSet, data as of 5/26/2023