Monday, June 28, 2010

A Cautionary Note On the Data Ahead

With the economic recovery steadily approaching a key juncture, the overall tone of the various economic releases may also change as a result, projecting an overall softer undertone that may help support the latest downward drift of bond market yields.

In the three most recent quarters, since the recovery got under way, economic growth has benefited heavily from the classic inventory cycle, which contributed 0.7, 3.8, and 1.9 percentage points respectively to GDP growth since Q3 2009; in some cases, like in Q4 2009, a faster rate of inventory accumulation accounted for 2/3 of the entire GDP growth. With the inventory dynamic slowly- but predictably- losing its fizzle, and the the boost from last year's fiscal stimulus waning by year end, a perceptible risk exists that, economic growth may be downshifting in the second half of the year, unless another sector of the economy makes up for that.

The implication of this is that pressure is building on employment growth to pick up materially in the coming months to support stronger income growth and consumer spending. The labor market statistics have been quite mixed recently, with private payrolls stalling, following a solid turnaround in the first quarter, and initial claims essentially treading water since the beginning of the year.

The relatively unimpressive picture of labor market conditions does not represent a direct threat to the viability of the recovery per se, as the latter has already entered credibly the phase of a self-sustaining expansionary dynamic. However, it does hold the key to the pace of economic growth over the next 3 to 4 quarters.

Against such a background, the importance of the ever-pivotal employment report on Friday may be greater than usual.

With a potentially sizable number of temporary census workers laid off in June, the focus, once again, should be on private payrolls, which have averaged a fairly respectable 139,000 in the last three months. Even if the nominal payroll print for the month is only marginally positive, or even a small negative, a gain in the 150,000 to 200,000 range for private payrolls would be encouraging and consistent with economic growth plowing ahead at a solid clip. However, a private payroll gain in June comparable to the disappointing 41,000 reported for May may require a reassessment of the working assumption that the recovery can sustain a growth rate in the 3 1/2% to 4% range into early 2011.

Time is running out for the employment picture to show its hand.

Anthony Karydakis

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