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June 14,15 2016 FOMC Meeting

In a Nutshell: “Slowing job growth seems to have spooked the Fed and the members are becoming less certain about multiple rate hikes this year.”

Rate Decision: Fed funds rate range maintained at 0.25% and 0.50%

Until the May employment numbers were released, there was a feeling that we could get an increase in interest rates either at the June or July FOMC meeting. My, how one weak number can change just about everything. Now, the Fed members seem to be trending toward just one rate hike and who knows when that will be. Of course, it only took a few months to go from two or three hikes to one, so don’t be surprised if the amorphous blob that seems to be the monetary authorities transforms into a two rate increase group by September.

The statement released after the meeting didn’t really provide a clear indication of the thinking of the participants about the economy. Actually, it was hard to figure out what the Committee thought. Consider what was written: “The pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up. Although the unemployment rate has declined, job gains have diminished. Growth in household spending has strengthened. Since the beginning of the year, the housing sector has continued to improve and the drag from net exports appears to have lessened, but business fixed investment has been soft.” Some things were better, some were worse and some were, whatever. In other words, obfuscation rather than clarity seemed to be the main purpose of the statement on growth.

Though the statement reflects the yin and the yang of the recent economic data, the economic projections, which are released every other meeting, were decidedly downbeat. Instead of just one member expecting only one rate hike this year, that number has ballooned to six. Estimates of growth for this year and next were downgraded even as 2016 inflation expectations were increased. And maybe most telling, the median funds rate projection was reduced to 1.6% in 2017 from 1.9% and the to 2.4% from 3% for 2018. Those are large changes.

So what has happened since March 16th, the last time the projections were released? The only significant change was a slowing in job gains. Do the Fed members really believe that the initial round of job estimates bear any resemblance to what the ultimate numbers will look like? It is hard for me to believe that is the case. Keep in mind, according to BLS, “the confidence interval for the monthly change in total nonfarm employment from the establishment survey is on the order of plus or minus 115,000”. Really, Fed members are making interest rate projections based on employment numbers that have huge variations around the estimates?

I don’t know what to say. Today, producer prices rose faster than expected as goods costs accelerated and the softening in services disappeared. Yesterday, the inflation story was sharper than expected import price increases. While manufacturing production fell, retail sales were solid in May and that came on top of a robust gain in April, indicating the consumer is spending like crazy. In other words, the economy has hardly fallen on hard times, yet the way the Fed members have reacted, you would think a major slowdown is coming.

So, what will the Fed do this year? I still expect two rate hikes. It is looking more like a September one will be the first, followed by one in December. Even a strong June employment report is not likely to get a rise out of the members, given the pretty dovish projections. They need some time to walk back these numbers and there may not be enough solid data for them to do that before the July 26-27 meeting.

(The next FOMC meeting is July 26-27, 2016.)

April Job Openings, Hires and Quits

KEY DATA: Openings: +118,000; Hires: -198,000; Quits: -36,000

IN A NUTSHELL: “Hiring may be slowing, but it is not because the need for workers is declining.”

WHAT IT MEANS: We have had two consecutive disappointing payroll numbers and it is unclear if that is due to a lack of demand or a lack of supply. The April Job Openings, Layoffs and Terminations (JOLTS) report provides some insight into the situation. Firms are simply not bringing on workers nearly as rapidly as their need for new employees is growing. Job openings expanded solidly in April and are now back at their record highs, even as hiring slowed. Trade, transportation and utility companies had large increases in unfilled positions. Manufacturing firms hired more but still couldn’t meet their growing needs. There were a variety of other sectors, including finance, information, health care and education that couldn’t meet the growing demand for workers, but hiring in most of those areas fell. That suggests firms couldn’t find the workers they wanted. In contrast, openings in professional and business services fell sharply, as did hiring. This sector may be softening.

One of the key measures in this report is the quits rate. It indicates the willingness of workers to leave their jobs. The number and rate of quitting eased in April. While the rate is nearing historic highs, it still has a little way to go and the ups and downs in this number points to continued uncertainty on the part of workers as to the strength of the labor market.

 MARKETS AND FED POLICY IMPLICATIONS: The hand wringing over the May jobs report maybe misplaced. Yes, payroll increases are slowing, but it doesn’t look as if it is because the demand for new hires is dropping. Indeed, it looks like the need for workers is rising but for whatever reasons, firms are just not hiring. It may be because prospective employees don’t have the skills, or it could be because firms are unwilling to pay the price to attract the needed people. Most likely it is a combination of the two and that is important in understanding the dynamics of the market and the meaning of the jobs numbers. The slower rate of job creation may not be due to a slowing economy given the rise in job openings. Firms will either have to start paying more or figure out a way to raise productivity. For the past few years, firms have not done a good job of increasing worker efficiency, so it might be time for CEOs to start rethinking their strategies. Piling on more responsibilities and cutting back or limiting compensation gains doesn’t seem to be cutting it. Will they learn that lesson? Got me. As for the Fed, and especially Chair Yellen, this report reinforces her belief that the labor market is “close to eliminating the slack that has weighed on the labor market since the recession”. It’s hard to argue that there is slack in the market when we are at record highs for job openings.

May Private Sector Payroll Gains, Layoffs and Weekly Jobless Claims

KEY DATA: ADP: +173,000; Layoffs: 30,157; Claims: 10,000

IN A NUTSHELL: “The labor market is in decent shape as firms are holding on to their workers as tightly as they can.”

WHAT IT MEANS: While tomorrow’s employment report will be looked at as the be-all, end-all of labor market data, there are other elements of the market that Fed members watch. Fed Chair Yellen is focusing on labor market tightness, not just job gains or the unemployment rate itself. Thus, we need to look at some of the other numbers that provide the texture of the labor market. Layoffs are one of them. Challenger, Gray and Christmas reported that in May, layoff announcements fell to their lowest level in five months. The energy sector continued to lead the way, though the rate of job cuts is slowing sharply. Rising energy prices is apparently helping, though there aren’t a lot of workers left to cut in this sector (just a joke). The summer education cuts were also announced, but that is normal. Manufacturing was also a major player, confirming that this sector is still wobbling along.

The sharp decline in jobless claims adds to the belief that firms just don’t want to let go of their employees. We are nearing record low territory again as the early spring rise has been unwound.

As for tomorrow’s jobs numbers, ADP estimated that payrolls rose more in May than they did in April. As we saw with the layoff announcements, manufacturing continues to cut back. Large companies hired more people, but it would be nice if they actually did it with some gusto.

 MARKETS AND FED POLICY IMPLICATIONS: The labor market is in good shape, but how good we will not know until tomorrow. Even then, the data may be a confusing until we can exclude the Verizon strikers and temporary fill-ins from the numbers. But I expect the additions to payrolls to be near 200,000, adjusting for the Verizon issues and the unemployment rate to decline to 4.9%. Maybe more importantly, the hourly wage number should be solid. If it rises by 0.3%, the wage acceleration that we have been seeing lately could be viewed as becoming systemic, something that the Fed Chair needs to see before she backs sustained rate hikes. By sustained, I am talking about every other meeting for maybe a year. Then sustained would become every meeting. With the employment report less than a day away, it only makes sense that investors act cautiously. as this report has the potential to surprise in either direction.

May Supply Managers’ Manufacturing Survey, Help Wanted OnLine and April Construction

KEY DATA: ISM (Manufacturing): +0.5 point; Orders: -0.1 point; Employment: 0/ HWOL: -285,800/ Construction: -1.8%

IN A NUTSHELL: “If some members of the Fed were looking for weakness to hang their no-rate hike hats on, today’s numbers should suffice.”

WHAT IT MEANS: Things were looking up for the economy, at least when the April data were coming out. But May is a new month and maybe not a great one. The Institute for Supply Management’s Index of Manufacturing rose nicely over the month, but this was one of those look at the details not the headline number. Yes, the sector picked up some steam in May, but it is not clear if that is sustainable. New orders grew decently, but not quite as rapidly as in April, while production slowed appreciably. As a result, hiring was flat and thinning order books don’t argue for stronger output going forward. In other words, let’s wait and see where this sector is going.

On the labor market front, conditions may be softening. The Conference Board’s Help Wanted OnLine measure tanked in May after having been largely flat in March and April. You have to go back to January 2014 to find a level of want ads this low. The fall off in demand for workers was spread across the country as every region reported a decline. Only 1 (Seattle-Tacoma) of the 52 largest metro areas saw labor demand increase. With ads dropping, the gap between demand and supply, as measured by the number of unemployed, narrowed.

Construction activity nosedived in April. There were declines in residential and nonresidential activity as well as public and private construction. There were few categories that were up, making this a pretty ugly report.

MARKETS AND FED POLICY IMPLICATIONS: Today’s numbers don’t provide the foundation for the Fed to raise rate in two weeks. But today’s numbers will be overshadowed by Friday’s employment report. After the more modest April gain, the consensus has moved down to the 150,000 to 175,000 range, especially given the potential of job losses due to the Verizon strike. That will be factored into any detailed discussion. The help wanted numbers seem to support a number in that range and possibly toward the lower end of it. The unemployment rate is expected to decline and if that happens, the focus will shift to the hourly wage number. The year-over-year increase has been accelerating and if that continues, it would be a warning that even more modest job gains are enough to put pressure on the labor markets. The economy is not booming; that is obvious. However, consumers seem to be spending but businesses are once again moving to the sidelines. Maybe it’s the uncertainty about the Fed or the presidential election, but if CEOs don’t want to hire or invest strongly, it is going to be hard to get the economy to accelerate. The Fed needs to get its communications straightened out because it is creating more bad than good and it will be interesting to see what Fed Chair Yellen has to say on at her press conference on June 15th.

April Consumer Spending and Income, May Consumer Confidence and March Housing Prices

KEY DATA: Spending: +1%; Disposable Income: +0.5%; Prices: +0.3%; Excluding Food and Energy: +0.2%/ Confidence: -2.1 points/ Home Prices: +0.1%; Year-over-Year: +5.2%

IN A NUTSHELL: “Consumers have the income to spend and they are doing just that, but they still don’t seem happy about things.”

WHAT IT MEANS: Watch what they do, not what they say is a good phrase to live by when it comes to consumer spending. Household financial conditions are improving as personal income rose solidly in April. Wage and salary increases were robust for the third time in four months. It finally looks like the tight labor market may be forcing businesses to pay up for workers. With the money to spend, households are out there hitting the malls, the dealerships and the dry cleaners – demand for durables, nondurable and services were all up sharply. Spending exceeded income, so the savings rate slipped. It is still reasonably high, though, indicating the households are not getting too carried away. As for prices, they rose solidly, largely on the back of strong energy price increases. However, even excluding food and energy, they were up solidly. Both the overall measure and the core index increases over-the-year will hit the Fed’s target of 2% by the fall, if they continue to rise at the same pace as they did in April.

You wouldn’t know that household financial conditions are getting better by talking to people. The Conference Board reported that consumer confidence fell in May, a surprise given the sharp rise in the University of Michigan’s Consumer Sentiment Index. The labor market is solid, wages are rising and job openings are near record highs, so people should be upbeat. Maybe it’s the thought of the next election that is getting them down, who knows? But they are not a bunch of happy campers. Views on both current and future conditions worsened and respondents worried that jobs would become more difficult to get both now and going forward.

On the housing market front, the S&P/Case-Shiller seasonally adjusted National Home Price Index rose modestly in March. Interestingly, the index of twenty large metro areas showed a much larger gain. I guess the rest of the country is not following those areas. Still, every one of those metropolitan areas, except Cleveland, posted an increase.

 MARKETS AND FED POLICY IMPLICATIONS: The consumer could push GDP growth above 3% this quarter. Consumption is already growing at a 3% rate and is likely to be higher.   Also, housing has started rebounding from its March low. A few more long security lines at strategic airports (those are ones where powerful members of Congress fly out of) and government spending just might be up sharply as well. Yet despite their actions, households are still cautious. It is hard to explain the decline in confidence that the Conference Board reported. The University of Michigan’s Sentiment Index increase better matches the changes occurring in family finances, but the divergence of the two measures makes you wonder.   But what the Fed needs to start seriously thinking about is their inflation measure. Prices are rising faster and it isn’t just gasoline. The Fed’s dual targets of full employment and trend (2%) inflation are within reach. The Fed is not likely going to wait until both measures hit or exceed their targets, which should happen in the fall. The real question is: Do they raise rates in June or July? A stronger than expected May jobs and wages report on Friday, could push them to act in June. The Verizon strike may have temporarily stunted the jobs number, so study the details even more closely than usual. Given all the uncertainty, it makes sense for investors to temporize this week.

April New Home Sales and May Philadelphia Fed Non-Manufacturing Survey

KEY DATA: Home Sales: +16.6%; Prices: +9.7%/ Phila. Fed: -8.9 points; Orders: +9.2 points

IN A NUTSHELL: “Households went out an bought lots of homes and vehicles in April and if that isn’t a clear sign of confidence, I don’t know what is. ”

WHAT IT MEANS: Just when you thought it was safe to say that the Fed would not raise rates again for a while, along comes the economy, which is showing clear sings that it is bouncing back sharply from the winter malaise. New home sales soared in April to their highest level in over eight years. The gains were in three of the four regions, with only the Midwest posting a decline. The Northeast, where sales had fallen so low that rather than reporting the number of homes sold they had started simply listing the names of people who bought houses (just joking), saw demand up by over 50%. Both the South and West increased by over 15%, so their gains were not too shabby either. But the real eye-opener was the median price number: It spiked and hit the highest level on record, as households started buying more expensive homes again. In April, 56% of the houses purchased cost over $300,000. In 2015, only about 49% of the houses cost that much. That is good news for builders, who just may start putting more shovels in the ground.

The Philadelphia Federal Reserve Bank’s May survey of non-manufacturing firms showed some very odd results. While respondents said the region’s economy slowed, their own activity picked up, led by a surge in new orders and sales. Huh? Conditions are worsening even as demand is rising and hiring is accelerating? And, optimism about both the local economy and their own businesses faded. A special question was asked concerning wage costs and price inflation. Respondents expect wages to rise by about 2.5% over the next year, which is below the 3% that manufacturers forecasted, but still solid. On the inflation front, both service and manufacturing employers expect consumer prices to rise by about 2.5%, which is above the Fed’s target. In other words, most businesspeople in the MidAtlantic region expect inflation to pick up over the next year to levels that would lead to more Fed rate hikes.

 MARKETS AND FED POLICY IMPLICATIONS: The FOMC April minutes said that a rate hike in June was a possibility if the economy continued to show signs of rebounding. Well, housing is one sector that still has lots of room to run and I am no Exaggerator when I say that it can win. (Sorry about that.) A strong housing market, where starts and sales are rising solidly, significantly affects other parts of the economy. Existing home sales rose, though modestly in April, while new home demand jumped. While the May numbers will likely be softer, there is a clear upward trend in sales and prices that should trigger a new round of construction. We started the second quarter with some really good numbers for housing, vehicle sales and retail sales, pointing to renewed strength in the consumer sector. But those increases have to be sustained. Before the June14-15 FOMC, we get the May jobs numbers, vehicle sales and retail sales, so the Committee should have enough information to make a decent guess at second quarter GDP. I have growth above 3% and the numbers are coming in strong enough that most forecasters will likely be revising upward their expectations. A number at or above 3%, with wages rising even modestly in May after the surge in April, should be enough to get he Fed to raise rates either in June or July. As for investors, if they keep in mind that slow growth means weak earnings – and earnings have been soft – then they should be happy with stronger growth and higher rates. But we shall see.

April Consumer Prices, Housing Starts and Industrial Production

KEY DATA: CPI: +0.4%; Less Food and Energy: +0.2%/ Starts: +6.6%; Permits: +3.6%/ IP: +0.7%; Manufacturing: +0.3%

IN A NUTSHELL: “With inflation accelerating slowly, housing rebounding slowly and manufacturing activity improving slowly, it is clear the economy is picking up steam slowly.”

WHAT IT MEANS: The Fed’s dual mandate means it has to target maximum employment at stable prices i.e., an unemployment rate in the 4.75% to 5% range and inflation at about 2%. We have pretty much been at the full employment target for several months and now inflation is making its way to the 2% rate. Consumer prices rose sharply in April led by a jump in energy costs. With oil prices steadily increasing, we should be in for some additional solid gains for a while. The rise in inflation was not just gasoline. Prices for food, medical care, shelter and transportation services rose as well. There were also a number of categories, though, where costs did decline, such as clothing, vehicles and, most importantly, cupcakes. In other words, there is an upward trend in inflation, but it is not across all categories.

On the housing front, conditions did improve nicely in April. Housing starts surged and permit requests rose solidly. But the level of construction is still well below the recent peak recorded in June 2015. Strangely, the problem has been in multi-family activity. With the rental market so strong, it was expected this segment would lead the way – and it did in April. But for the first four months of the year, multi-family starts were below the same period last year. And that was true for permit requests, so this segment seems to have stalled a bit. Looking forward, starts exceeded permits for the past three months, so don’t expect any major acceleration in building.

Manufacturing production rebounded in April as well, but the story is the same here. We get one negative month, one flat month and one positive month, and the cycle repeats. This sector is not showing a major upturn, though it does look like the declines could be over. The summer driving season is projected to be really strong and that could lead to additional output of gasoline. As for energy production, prices probably need to rise a little more before wells start coming back on line, but maybe the shut downs will cease.

 MARKETS AND FED POLICY IMPLICATIONS: Inflation is accelerating, but not at a rapid rate. Over the year, headline consumer costs were up 1.1%, which is still below target. However, one year ago, prices were falling. Excluding energy, though, prices were up 2%. At current levels, energy turns positive in September and the yearly rise accelerates for six months. In other words, by the fall, even the headline number should be above the Fed’s target. Excluding food and energy, the more common comparison, prices were up 2.1% over the year, marking the six consecutive months that core consumer inflation was at or above the Fed’s 2% goal. In other words, the Fed’s dual mandate is within its grasp. But Fed Chair Yellen is likely to hang on to the mediocre growth in housing and manufacturing to argue that a rate hike is not yet needed. And given that real earnings actually declined in April, as prices rose faster than wages, she can also say that wage pressures are not yet critical. So, these reports may hint that the Fed will have to do something in a few months, but the data don’t require that a rate hike occur in June.

April Retail Sales and Producer Prices

KEY DATA: Sales: +1.3%; Excluding Vehicles: +0.8%; Core: +0.9%/ PPI: +0.2%; Less Food and Energy: +0.3%

IN A NUTSHELL: “Reports of the consumers’ demise appear to be premature.”

WHAT IT MEANS: It’s been an ugly year for a lot of retailers and that showed up in the first quarter earnings numbers. But some hope may have appeared in today’s retail sales report. Households went out and hit the stores pretty heavily in April, even when you take out the rebound in motor vehicle sales. Almost every major category was up sharply. The only group that experienced a sales decline was building materials. However, those stores had been booming during the first quarter of the year and the year over year rise is still the highest of any of the categories except Internet sales. General merchandise demand was flat and restaurants saw a more modest increase, though that was good news given the declines they had suffered. So-called “core” retail sales, which exclude vehicles, gasoline, building supplies and food services were up sharply. The core closely follows the consumption number in the GDP, so they are looked at as an indicator of consumer demand.  

On the inflation front, wholesale prices rose moderately as goods costs led the way. It’s funny how rising energy prices changes the picture of inflation, isn’t it? Not really. By the fall, we could be seeing year-over-year energy price gains rather than declines and while we are talking producer prices here, those quickly make their way into consumer prices. That is also true on the food side and the drop in wholesale food costs is good news for consumers. An interesting change is the deceleration in services inflation. Prices did rise, but modestly. Service inflation, which is nearly two-thirds of producer costs, has been decelerating this year. When you look at the details, and this report has about fifty different special indices, there are no categories where inflation is high.

MARKETS AND FED POLICY IMPLICATIONS: Has the consumer decided that it is time to spend again, or are was the April uptick just a bump in the mediocre growth trend? I think it is real. Incomes are growing solidly and household balance sheets are in good shape. The job market is tight and people are quitting their jobs again, a sign of confidence. Consumer confidence seems to be soft, though, and it is unclear exactly why that is the case. My guess is that this is just one of those times where the data are strange and as we go through the rest of the spring and summer, we will see households actually spending their funds. That is, April is likely the start of something good. For the Fed, though, it’s not the start but the follow through that matters. One month is not enough for anyone to say happy days are here again for retailers. However, producer inflation is no longer declining and while it is hardly a worry, the trend is up. All-in-all, today’s reports tell the Fed that conditions are not nearly as soft as the GDP data seemed to indicate and while they have time when it comes to inflation, they may not have as much time as they thought as well.  

April Jobs Report

KEY DATA: Payrolls: +160,000; Private: 171,000; Unemployment Rate: 5% (unchanged); Wages: +0.3%

IN A NUTSHELL: “Job growth is not too hot, not too cold but not just right.”

WHAT IT MEANS: The economy has grown by just over a 1% annualized growth rate during the past six months, but job gains during that time frame were strong – probably stronger than would be expected given the economy. What has worried economists is that firms would not be able to sustain all that hiring, so the April increase in payrolls was a disappointment. But is it a warning sign? Maybe not. The last time job gains were this modest was last July, but that report was followed by six months of solid increases. One number doesn’t mean much. Second, it’s always about the details and those were mixed, not soft. On the positive side, manufacturing stopped its steep slide and actually added a few jobs. Health care was solid as was leisure and hospitality, while there were plenty of professional services positions were added. On the negative side was the government. Not surprisingly, the postal service continues to shrink and strangely, there were layoffs in local education. Why April? Got me. The energy sector is still in free-fall while retailers cut, rather than added employees. The retail decline happens periodically, but it is something to watch.

But the really good news for workers, and the issue for the Fed, was that wages rose sharply and the gains are accelerating. In addition, hours worked were up and that implies that income growth in April was strong. One of the reasons wage gains are picking up is that the unemployment rate is near full employment. Yes, it remained at 5%, and yes, the labor force shrunk, but it is up 1.2% over the year. That is well above a demographically supportable, sustainable rise. What appears to be happening is that people are indeed coming back into the workforce, as would be expected when the labor market tightens. A one-month decline in the labor force or the participation rate means nothing as both are rising over the year.

MARKETS AND FED POLICY IMPLICATIONS: This was one of those reports where the headline number and the details were largely in synch. There were good parts and weak parts but it was mezza mezza overall. The level of job gains, while mediocre, is still large enough to stabilize if not keep the unemployment rate slowly falling. There are clear signs the tight labor market is causing firms to finally pay up for workers, and that really is the story here. Workers are starting to quit again and businesses continue to complain about their inability to find suitable workers. That raises the question whether the soft job gains in April was the result of a lack of demand or a lack of supply. If you cannot the workers you need, you cannot hire more workers. That translates into higher wages in order to retain workers. Chair Yellen has made the argument that soft wage gains is an indicator of a labor market that has yet to reach full employment. This report doesn’t force her to say that full employment is here, but it brings us much closer to that point. Even if the May report duplicates the April wage increase, I don’t think a rate hike at the June 14-15 meeting is likely at all. But unlike others, I believe the July 26-27 one is a possibility. If both the May and June reports contain strong wage gains, Chair Yellen will have problems supporting her stand. Also, as I have argued before, she wants to show that all meetings, not just ones with press conferences, are options for rate hikes. The July meeting would be a suitable one to prove her point. As for the markets, a report that is less than expected on job growth but more than expected on wage growth is a real conundrum. Maybe the less than stellar earnings numbers will remind traders that if demand is not good, earnings will not grow strongly. Instead, they should hope for a good economy, even if it means rising rates, rather than a weaker one that implies no rate hikes.

Layoffs, Jobless Claims, April Jobs, Productivity and Help Wanted Online

KEY DATA: Layoffs: 65,141/ Claims: up 17,000/ ADP Jobs: 156,000; Productivity: -1%; Labor Costs +4.1%/ Help Wanted: +39,000

IN A NUTSHELL: “The labor market is tight, but the tightening process may be slowing.”

WHAT IT MEANS: If Janet Yellen is laser-focused on the labor market, the data released over the past two days don’t indicate that conditions are firming sharply. Of course, tomorrow we get the jobs report, so everything could change. But until then, let’s review the recent data, starting with today’s the jobless claims report. While there was a pop in the number of people filing for unemployment insurance last week, that is not unusual. These data bounce around a lot. The four-week average is still at a level that says firms are doing everything they can to keep workers. That said, Challenger, Gray and Christmas reported an April surge in layoffs, led by the ever-shrinking energy sector. The total for the first four months was the highest since the 2009. Before you panic, the 2009 total was nearly three times this year’s number. Also, we have no idea where or when or even if they will occur. Still, firms seem to be announcing cut backs at a surprisingly high pace given the unemployment claims numbers and yesterday’s report by the Conference Board that online want ads rebounded.

Yesterday, there were a number of labor market reports. ADP’s monthly reading of April job gains came in below expectations as mid-sized businesses added workers at a lower than typical pace. However, the level was the same as the July 2015 number and job growth was very solid during the second half of last year. We may get a lower than expected number tomorrow.

But for me, the biggest eye-opener was the productivity and costs report. I have argued that the monthly hourly wage number is worthless, even if the markets want to make believe it contains useful information. I prefer to look at the more complete compensation data that is contained in the productivity and Employment Cost Index reports. Productivity continues to falter as firms are hiring but output is largely going nowhere. With compensation gains holding fairly steady, labor costs surged.  

MARKETS AND FED POLICY IMPLICATIONS: The labor market is tight but it doesn’t seem to be in the grips of a major shortage situation just yet. Firms are doing everything they can to keep their workers. Challenger, Gray and Christmas indicated companies are resorting to stay, not exit interviews. Instead, they might try raising pay, but of course that still is a non-starter for most firms. And that is the point. No matter how tight the market may be, companies are still willing to go without new hires and limit pay increases. For me, that is the biggest reason productivity is so weak. Let me say this again, wage increases drive productivity not just productivity drives wage increases. This is a simultaneous process that firms seem to think is a one-way relationship – productivity first, wage gains, maybe, second. Until workers have reasons to work harder (i.e., greater compensation), they will find ways not to work harder. That is human nature and failing to understand that will keep productivity and earnings down. But the Fed will worry about compensation growing slowly and say the labor market is not tight. And the Fed will see productivity is weak and say the economy is at risk. What the members will miss is the interaction of the two and by doing so, miss what are some of the real problems in the economy.