Monday Update: More Positive Surprises

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Jul 11, 2016 2:47:56 PM

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monday updateFor the second week in a row, the U.S. economy offered positive surprises. Both the service sector—the largest portion of the economy—and the employment market showed marked improvement, with data coming in well above expectations. Coupled with results from the previous week, the latest numbers suggest the economy has started to move again.

A look at last week’s data

FOMC minutes and trade report: no news is good news. As expected, the minutes from the Federal Open Market Committee meeting didn’t contain much news. The takeaway from an investor’s perspective was that the Fed seemed very concerned about the weak May jobs report, as well as international risks, particularly Brexit and China. Overall, this was considered a dovish report and made a rate increase in September seem unlikely, which boosted market sentiment.

Also as expected, the international trade balance report showed that exports dropped by a small amount (0.2 percent in nominal terms) while imports increased, widening the deficit. This should have a small negative effect on growth, but it has already been factored into estimates.

Service sector accelerates. The first positive surprise came from the ISM nonmanufacturing survey, which covers the service sector. After falling to a two-year low of 52.9 in May, the survey rose to 56.5—the largest monthly increase since early 2008 and well above expectations of an increase to 53.4. The index is now at a seven-month high and, along with last week’s recovery of the manufacturing index to a 16-month high, suggests economic growth is accelerating. Details were positive across the board, with new orders up substantially and employment moving back into expansion territory. This was a very promising report, and growing retail and service sales suggest it may be poised to increase further in coming months.

Jobs bounce back strongly. The other (and even more important) positive surprise was the June employment report, with 287,000 jobs created, well above expectations of 180,000 and the largest gain since last October. The data went a long way to relieve concerns about the employment market from May’s very poor number (38,000 jobs revised down to 11,000). The details also looked good:

  • Private payroll growth rose from a loss of 6,000 as revised to a gain of 265,000, while manufacturing went from a loss of 16,000 as revised to a gain of 14,000.
  • Average hours worked remained steady, at 34.4, while average hourly earnings growth dropped to 0.1 percent for the month but moved up to 2.6 percent for the year.
  • Both the unemployment and participation rates rose, from 4.7 to 4.9 percent and from 62.6 to 62.7 percent, respectively, as more workers moved back into the labor force. Part of the gain came from the end of the Verizon strike, but this report still represents a return to very healthy job gains and speaks well for the economy going forward.
The week ahead

This week kicks off with the release of data on consumer prices. Expectations are for a steady increase, with headline inflation up by 0.2 percent for the month and 1.1 percent for the year. The headline number continues to be low, as gasoline price declines from 2015 remain in the annual data. The core inflation number, which excludes food and energy, is also expected to rise 0.2 percent on the month but 2.2 percent on the year. As the decline in gas prices last year rolls out of the data, we should soon see the two numbers converge, which should start to increase pressure on the Fed to raise interest rates.

Retail sales numbers are released on Friday and are expected to increase slightly, by 0.1 percent for the headline figure, down from 0.5 percent for May. The core figure, which excludes gasoline and autos, is expected to increase by considerably more, or 0.4 percent, consistent with May’s result. The difference is due to an expected decline in auto sales, which stands to pull the headline figure down. Core sales growth should remain very healthy, however, as the auto sales decline is simply a partial giveback of previous strong gains.

Also on Friday, industrial production is expected to move from a decline of 0.4 percent in the previous month to a gain of 0.2 percent on an increase in utility output. Manufacturing is also expected to move from a decline of 0.4 percent to a gain of 0.3 percent on substantially better industry surveys and expectations. If these two reports are indeed positive, it would be more evidence that this sector may be stabilizing.

Overall, if expectations are met, this week’s data should confirm the likelihood of continued economic growth.

Have a great week!

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