The March 2015 non-farm payroll report was certainly a disappointment.
The number of jobs grew by a mere 126,000, versus economists’ consensus expectation of almost twice that amount. What makes the March result especially disappointing is that employment was the last encouraging statistic left standing in the first quarter’s overall economic slowdown. On top of that, the U.S. Labor Dept. revised both January’s and February’s payroll growth numbers downward.
By now, you have probably heard the recurring theme in numerous publications and media outlets: It was all because of the weather, genius!
I have no doubt that some of the softness was weather related. At the same time, I also firmly believe that we can’t attribute all of it to the weather.
As I have said many times, in a deleveraging world with deep capital markets and free floating currencies, the likelihood that policies and prospects for growth can diverge greatly among different countries is just not realistic.
That is especially true in the case of the U.S. due to the dollar’s reserve currency status. Any expectation of significant differential in U.S. monetary policy will lead to dollar strength, which in turn will lead to U.S. demand leaking out to the rest of the world. That is precisely what is happening now.
Unfortunately, none of the models of past dollar strength can be expected to predict this because we haven’t had an episode of dollar strength with minimal growth in private credit, especially household credit. As a result, any forecast of the impact of the dollar on the U.S. economy based on data from the past 30 years is just not a very reliable forecast.
None of this implies that the U.S. economy will not recover over the rest of 2015. I believe it will, as some of the effects of winter weather and the strong dollar on U.S. growth fade over the next few months. In my view, the underlying growth prospects for the U.S. economy are actually quite good and the economy is likely to rebound from the low levels seen in the first quarter. At the same time, it is also true that most analysts’ growth expectations are significantly above trend, just as they were coming into 2015.
Minimal Impact on Federal Reserve Policy
I also believe the March payroll number will not have a meaningful impact on what the Federal Reserve is likely to do. Fed Chair Janet Yellen’s speech on March 30 was probably as clear a picture of her thinking as we are likely to get from any policymaker.
Essentially, she said the Fed is likely to look past any weakness in the first-quarter growth or inflation outlook. Given last year’s experience, Fed policymakers will classify the growth slowdown as an aberration rather than the trend. I doubt that even a modestly weaker employment number for the quarter, compared with the robust expectations – which are totally out of sync with the rest of the growth picture – will change their minds.
In their view, while we may debate the underlying growth trend, it is stable enough for the Fed’s interest rate policy not to remain at zero. As a result, policymakers are likely to raise rates at some point this year. Further, they believe that, given the lag in the impact of Fed policy on the macro economy, it is not necessary to wait until they have achieved their policy objectives to tighten. Remarkably, Yellen effectively said in her speech that even wage growth – which would be the tell-tale sign of labor market strength – is not that relevant.
In other words, nothing in the short-term data is likely to get her and her team off the tightening path.
However, being an astute policymaker, she also left herself a way out. The following is astounding in its clarity:
“… I would be uncomfortable raising the federal funds rate if readings on wage growth, core consumer prices, and other indicators of underlying inflation pressures were to weaken, if market-based measures of inflation compensation were to fall appreciably further, or if survey-based measures were to begin to decline noticeably.”
In a further example of being an astute policymaker, in the same speech, Yellen also tried to change the topic. Instead of focusing on the expected first policy tightening since June 2006, she instead wants the market to focus on the pace of tightening. That is astute indeed. That way the Fed can have its cake and eat it too. They can tighten policy but, at the same time, not have the policy bite the economy and financial markets too much.
The Bottom Line for Investors
So, what is an investor to do?
The bottom line is rather simple:
- The U.S. growth rate is slowing. It may pick up again over the next few quarters but, in my view, it was never going to be above trend anyway.
- That said, the Fed is still likely to tighten at some point this year.
- That tightening probably won’t have a meaningful impact on long rates, which are likely to stay quite low for a long time. That means the environment remains attractive for credit over government bonds.
The combination of a slowdown in economic growth and the strong dollar has created a bit of an earnings and momentum headwind for the equity markets. They sure feel squishier today than they did over the past few years. But if long rates do not go up much, in an environment where rates are going to remain low for a while, equities are still quite attractive for longer term investors; they just have to endure the short-term pain.
While the U.S. growth outlook may be somewhat better than the rest of the world’s, currency regimes and differentiated economic policies will undoubtedly transfer some of that growth overseas. That is especially true in a deleveraging world when other central banks are easing while the Fed is moving in the opposite direction. Europe’s growth trajectory, as opposed to its level of growth, appears decent. Further, valuations and central bank policies in some of the emerging markets are also starting to move in the right direction.
Therefore, global equities, as opposed to just U.S. equities, are the asset class of choice. Global diversification is as important today as it has ever been.
And that is true no matter what the weather is.
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Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes and geopolitical risks. Emerging and developing market investments may be especially volatile.
Bonds are exposed to credit and interest rate risks (when interest rates rise, bond/fund prices generally fall). Below-investment-grade (“high yield” or “junk”) bonds are more at risk of default and are subject to liquidity risk.
SOURCE: OppenheimerFunds Blog – Read entire story here.
