May Consumption and Income and June Consumer Sentiment

KEY DATA:  Consumption: 0%; Disposable Income: -2.3%; Prices: +0.4%; Over-Year: +3.9%; Ex-Food and Income: +0.5%; Over-Year: +3.4%/ Sentiment: +2.6 points

IN A NUTSHELL: “The economy remains on track, despite some of the craziness in the data.”

WHAT IT MEANS:  Once again, we run into the problem of separating the headline number from the trends and the details.  Today’s data may look ugly but that is just not the case, at least when it came to income and consumption.  Yes, flat May consumer spending was nothing to write home about.  But there was a large decline in durable goods demand that can simply be explained by the drop in vehicle sales from an unsustainably high April pace.  The May annualized rate of vehicle sales was actually pretty good.  Also, services spending rose sharply, indicating consumers are back out doing the things they had given up during the pandemic.  As for income, the decline was the result of the changes in flows of government assistance.  Wage and salary gains were fairly normal – decent but not great.  As for the inflation numbers, they were troublesome.  The headline and core price measures, which excludes food and energy, were up sharply and the change from 2020 accelerated once again.  But even here, there are some special factors.  The shortage of vehicles, in the face of strong demand, has led to a surge in vehicle costs.  That should settle down once the chip supply problem is eased.  And I doubt we are going to see the surge in energy costs, which were up over twenty-seven percent since May 2020, repeated.  Inflation should settle down, but as I have noted before, what really matters is where it settles down to. 

Consumer confidence will play a major role in determining the strength of future spending decisions and it picked up a touch in June.  However, the rise in the University of Michigan’s Sentiment Index was nothing special.  Most disconcerting was that the entire increase came from sharply rising expectations, as the current conditions measure declined.  With so many states ending restrictions, it is hard to understand why people think growth is moderating, but that seems to be the case.IMPLICATIONS: Given that the federal government has been controlling income and state governments handling the reopening of the economy, it should not be surprising if there are some major ups and downs in the economic numbers.  Consequently, we really don’t know the extent to which the private sector will be picking up the slack that ultimately will occur when the stimulus funds run out.  That uncertainty is something the markets and especially the Fed will have to live with.  The markets see no evil and are reacting accordingly.  The Fed, though, is somewhat unsure.  There are no clear signs that the monetary authorities want to end the bond-buying stimulus and that is good for the markets.  But the massive additions to liquidity seem totally unnecessary, unless the members don’t know what the economy will look like once the private sector must stand on its own.  So being cautious makes sense.  It also makes sense if the Fed truly believes that once the current global supply chain issues are resolved, inflation will eventually return to its desired trend rate. There appears to be a total discounting of the idea that the current pricing power could be sustained.  Will firms get use to the ability to keep earnings up by raising prices?  Over the past couple of decades, the fear of raising prices has controlled inflation. The idea that that the same fear will reappear after companies have seen the benefits of price increases may be a wishful thinking.

May Retail Sales, Industrial Production, Producer Prices and June Housing Market

KEY DATA:  Retail Sales: -1.3%; Excluding Vehicles: -0.7%/ IP: +0.8%; Manufacturing: +0.9%; Vehicles: +6.7%/ PPI: +0.8%; Personal Consumption: +0.4%/ NAHB: -2 points

IN A NUTSHELL: “The consumer is spending, just not as rapidly, as prices continue to soar.”

WHAT IT MEANS:  About once a month we get a data dump and today was one of those days.  The big number was the retail sales report, which provides some insight into consumer behavior.  Households cut back their spending pace in May sharply after spending like crazy in April.  We knew that was going to happen as the April vehicle sales pace was not sustainable.  But even excluding vehicles, demand fell sharply.  The details, though, were really mixed. There were huge declines in purchases of furniture, electronics, building supplies and general merchandise.  However, we bought lots more food, both at home and in restaurants, and sales of clothing, health care products and gasoline also rose.  As for the internet, demand was down there as well.   

Industrial output surged in May as the vehicle sector picked up the pace sharply.  This sector has been constrained significantly by the shortage of chips and that supply problem remains a major concern.  The production of both consumer goods, business equipment and technology products picked up significantly, indicating that demand is expanding across the entire economy.

The cost of production continues to rise dramatically.  The Producer Price Index was up sharply in May and over-the-year, it has risen by 6.6%.  But the details are not quite as distressing – or threatening.  The costs of personal consumption products are not increasing as rapidly as the overall index and that points to high but not huge gains in consumer prices. 

Housing activity eased a touch in early June.  The National Association of Home Builders’ Index declined moderately, led by weakness in the Northeast and West.  Still, the measure is indicating that the market is now only red hot instead of white hot.  Whether that is due to a lack of demand or supply is not clear from these numbers, but all other indications are that it is an inventory issue.  IMPLICATIONS:The Fed is starting its two-day meeting today and the latest data, when taken out of context, would look to be troubling.  Consumer spending declined, the housing sector eased back, and business costs continue to soar.  But those numbers don’t tell the whole story as consumption is still strong and housing remains robust.  The rise in production is a clear sign that growth is not faltering.  But for the monetary authorities, the one concern could be the continued surge in the cost of doing business.  The members want to get the tapering process started and there is every reason to start sending messages that the economy not only doesn’t need any additional help, but could use a bit of moderation.  However, I don’t think they have reached the point where they are willing to say that.  It is not necessarily a fear of another taper tantrum and a market meltdown.  I think the major concern for the Fed is the uncertainty about what happens when the government stimulus funds start to run out.  We are several months away from that point and then it could take at least six months to see how things settle out.The Fed appears willing to accept excessively high inflation for an extended period because it believes inflation pressures are only transitory.  The biggest problem with the sentence I just wrote is that no one has any idea what is meant by “extended period” and “transitory”.  The Fed likes to use words and phrases that are like rice cakes: They seem to have substance but are all air.  Those types of words provide flexibility and gives the members wiggle room.  And until they see that inflation expectations are no longer well anchored, the members will argue they don’t have to do anything.  So, I don’t expect much out of this meeting and tomorrow’s statement and press conference will not likely be that telling.  What needs to be watched are the inflation numbers in the economic projections table.  They were too low in the March report and how much they are raised will provide some insight into the concerns members have for future inflation.

May Consumer Prices and Inflation-Adjust Earnings and Weekly Jobless Claims

KEY DATA:  CPI: +0.6%; Over-Year: +5%; Ex-Food and Energy: +0.7%; Over-Year: +3.8%/ Hourly Earnings: +0.5%; Inflation Adjusted: -0.2%/ Claims: -9,000

IN A NUTSHELL: “Consumers are being battered by rising retail prices, while labor shortages and surging wages are hitting businesses hard, and there is little reason to think those trends will change anytime soon.”

WHAT IT MEANS:  No good deed goes unpunished and that is the case with the rapid reopening of the economy.  The upside is that growth is soaring.  The downside is that consumer inflation is surging, and labor problems are pressuring businesses.  Today’s data highlight those issues.  Let’s start with the Consumer Price Index, which showed that retail prices jumped again in May.  The solid increases were across the board.  Only gasoline and fuel oil prices fell, and that could turnaround in the June report. Prices climbed for just about everything else except medical services, and thankfully cookies and cakes.  The biggest gain was in used vehicles, which rose by over seven percent and have skyrocketed by nearly thirty percent since May 2020.  The rise over the past year in all consumer prices was the second highest in thirty years and that was also true when food and energy were excluded. 

The increasing costs of goods is not only hurting the consumer at the checkout line, be that online or in the store, but it is also eating into purchasing power.  While hourly wages rose sharply in May, when adjusted for inflation, they were down.  When you add the decline in weekly hours worked, it looks like income gains will be quite weak. 

Business are being battered on two sides: Commodity costs are surging, and labor shortages, which are driving up wages, are cropping up across the economy.  And it looks like things will get worse before they get better.  New unemployment claims fell again last week and given the way the economy is reopening, they should continue to decline for weeks to come.  But as solid as hirings have been, they cannot keep up with the rise in job openings, so firms are hanging onto their workers as tightly as possible.  Thus, layoffs should continue to fall as will the unemployment rate.  That said, it will take a very long to time before the rate, which is currently 5.8%, gets back to the 3.5% just before the pandemic hit.

IMPLICATIONS:  Today’s data show what happens when demand suddenly surges while supply fails to keep up.  The problems in the global supply chain are creating shortages and that is forcing up both producer and consumer prices.  In a normal economy that is growing at trend, the pressure on costs would be elevated by not sky high.  But we are not in a normal economy and the sudden ebbs and flows of growth have created outsized impacts.  Firms love the jump in demand, but they don’t like the fact that they cannot get all the inputs they want, including labor, and therefore they are paying a lot more for their supplies and workers.  On the other hand, the sudden surge in demand is allowing them to pass through those higher costs to end users.  The result is the highest inflation in decades.  Will the elevated inflation rates be temporary, as the Fed thinks or hopes?  It depends upon what you mean by temporary.  Inflation could easily remain above three percent for the next year, especially if the rest of the world recovers more rapidly.  As I have noted before, the key will be inflation expectations.  The Fed members seem to believe that expectations will remain well contained, even in the face of evidence that they are becoming unmoored.  I expect the Fed will be accepting of inflation running well above its 2% average for an extended period, possibly all through 2022.  The rate was almost always below the target for over a decade, so it will take quite a long period of high inflation to bring a medium-term average up to 2%.  But that patience can only be sustained if expectations stay low, so investors should be watching not just the inflation rate but also the measure of inflation expectations.  They should also recognize that the labor shortages will not magically disappear when the enhanced unemployment money runs out.  Wage gains are not going to suddenly flatline.  Thus, businesses will continue to be pressured by rising commodity and wage costs and it will be hard to make it up in volume.  To maintain margins, firms may have to keep raising prices.  But that will accelerate inflation further.  Is wage-price inflation back?  We shall see.    

April Job Openings and Trade Deficit and May Small Business Optimism

KEY DATA:  Trade Deficit: $6.1 billion narrower; Exports: +1.1%; Imports: -1.4%/ Openings: +998,000; Hiring: +69,000; Quits: +384,000/ NFIB: -0.2 point.

IN A NUTSHELL: “The only thing keeping job growth down is the ability to find workers.”

WHAT IT MEANS:  Over the past two months, almost 840,000 new positions were added to the economy, and some are calling that weak.  I don’t know what yardstick is being used, but it isn’t weak.  But there is a reason why we haven’t seen even better payroll increases and it isn’t because of a lack of need.  In April, the government’s Job Openings and Labor Turnover Survey (JOLTS) posted its largest number of job openings and the rate of openings also hit a record high.  Nearly a million additional positions went wanting.  That is unheard of.  Businesses are doing their best to hold the line, as hiring rose, though somewhat modestly given the need, and layoffs declined.  However, workers are quitting at a record rate and the level is exceeding hiring.  So, when you add the reopening of the economy to strong growth and rising quit rates, it should surprise few that job openings are soaring. 

Another sign that the labor market is having structural issues was seen in the May National Federal of Independence Business’ report.  Optimism, which should be surging, was down a tick.  But more importantly, the report noted that “May is the fourth consecutive month setting a new record high reading for unfilled job openings.”  Skilled labor is extremely scarce as “Forty percent have openings for skilled workers”.  At the same time, a growing percentage of firms are in the market for workers, so this problem is not going away anytime soon.

On the trade front, the deficit narrowed sharply in April.  That is good news, as fewer dollars flowed out of the economy into foreign economies.  But this closing of the gap is not likely to be sustained, as imports of consumer goods and vehicles fell sharply.  The economy is booming, and the total import drop may have only been due to the outsized 7.5% gain posted in March.  The economy is expanding way to strongly for imports to be declining. 

IMPLICATIONS:  The labor market is facing a set of uncertainties it has never seen before.  Yes, there have been labor shortages before, but not at current levels.  There is government policy that, at least to some extent, has elevated the number of those receiving unemployment compensation.  But maybe most importantly is the issue of reopening offices and whether employees can or will work from home.  Some CEOs may believe that workers should “get over it” when it comes to the commute, but for workers who have a choice of where to work, they just may not want to get over it.  Working at home may be a key factor in retention.  Workers are quitting at record rates and while we don’t know for certain why that is happening, work location is likely a factor.  For those who prefer working at home or a hybrid structure, the demand to return to the office may be a reason to look for other another position.  Just a couple of years ago, we were talking about how Millennials viewed a job as a steppingstone, not a career, so loyalty to a company was not a major factor in employment decisions.  If you add work from home to the mix, we could be in for a major churn in employment.  That is good for workers, as companies will have to bid even more to attract them.  Firms may have to pay up to poach workers, even if some of that compensation comes as locational flexibility.  Retention and attraction policies will have to move to the forefront if businesses are to meet the growing demand.  How that plays out is hard to predict, but it will be very interesting to watch, especially for investors.  For many companies, the ability to effectively manage their workforce in this uncertain labor environment could become the critical factor in profitability. 

May Consumer Confidence, April New Home Sales and March Housing Prices

KEY DATA:  Confidence: -0.3 pts, Present Conditions: +13.4 pts, Expectations: -8.8 pts/ Home Sales: -5.9%; Prices (Over-Year): +20.1%/ Case-Shiller (Over-Year): +13.2%; FHFA (Over-Year): +13.9%

IN A NUTSHELL: “Some concern about the future is creeping into the minds of consumers.”

WHAT IT MEANS:  Eventually, the massive growth rate will have to moderate, and it looks like households are expecting that to happen during the next six months.  The Conference Board reported that its Consumer Confidence Index was largely flat in May.  However, the details were surprising.  The Present Situation component soared, as respondents were quite happy about what is happening right now.  But they were not quite as sanguine about the futureHouseholds are concerned that both business activity and the labor market could cool going forward.  That is quite likely, but the resultant growth rate should still be solid.

Home sales may already be moderating.  Like the existing home report, new home sales backed off in April.  Of the four regions, demand was up only in the West.  But prices continue to soar, even with inventory starting to build.  As is the case with existing homes, the supply remains about two-thirds of what it needs to be, given the sales pace. 

Speaking of housing costs, two indices were released today and they both said the same thing: Prices are still soaring.  Both the Case-Shiller and Federal Housing Finance Agency’s (FHFA) national indices jumped in March and the year-over-year price gains continued to accelerate.  Every region in the FHFA index was up double-digits since March 2020.  Of the 20 major cities in the Case-Shiller measure, only Chicago posted a single-digit increase (9%).  The home price inflation is accelerating across the nation.   IMPLICATIONS:The housing price increases are showing no signs of easing up and if you talk to realtors, they don’t think it will for quite a while.  It’s unclear how long “quite a while” is, but it looks like conditions will stay strong into the fall.  What may be at risk is sales.  The rapidly rising prices are starting to impinge on affordability and if mortgage rates rise as inflation accelerates, then some buyers, especially first-time home buyers, could be forced out of the market.  Continued double-digit, or even high single-digit home price increases are not healthy, and we need to start considering what it will take to start calling this a bubble.  I am not prepared to do so quite yet.  This is not a speculators housing market, as most purchasers are homebuyers, not investors.  And most of the homebuyers have the incomes to afford their purchases.  It looks like both the lenders and regulators learned their lesson from the housing bubble and are not stretching things to the limit.  The market is likely to decelerate, not burst, and if that happens, the impact on the economy will not be major.  (Yes, Mr. Bernanke said the same thing fifteen years ago, but conditions are somewhat different right now.)  What is disconcerting is seeing consumer confidence slowing its rise.  Let’s see now, economic activity is getting back to where it was before the pandemic hit, the vaccines have allowed the economy to largely reopen, and job growth is really strong.  So why aren’t people more exuberant?I am not sure, but we might want to start blaming inflation. It is spreading and both consumers and business owners are seeing it up close and personally.  The Philadelphia Fed published a report today that showed that inflation expectations are jumping.  Respondents thought inflation would rise at a 4% pace not just in the next year, but also over the next ten years.  This mirrors, to some extent, the finding of the Atlanta Fed, which saw its business inflation expectations measure hit its highest level since it was created nine years ago.  Inflation expectations may be starting to lose its anchor, which is the Fed’s greatest nightmare.  Since both of those measures come from Fed-based research, Chair Powell is likely taking note.

April Existing Home Sales

KEY DATA:  Sales: -2.7%; Inventory: +10.5%; Median Prices (Over-Year): +19.1%

IN A NUTSHELL: “Low inventory continues to plague the housing market.”

WHAT IT MEANS:  Ask any realtor and they will say that the housing market is booming.  Yet the National Association of Realtors reported that existing home sales fell in April for the third consecutive month. Only the Midwest posted a gain.  Purchases dropped in the other three regions.  Weakness in the single-family segment accounted for the drop, as condo sales improved slightly. So, is the market weakening?  Hardly.  The problem seems to be inventory, even if it did improve sharply.  Given the sales pace, the number of homes on the market would have to expand by at least fifty percent to ease the problem and that is not likely to happen anytime soon.  As a result, prices continue to surge, especially in the single-family component, which was up over twenty percent from April 2020.  We must be careful comparing the early pandemic months with current numbers, but prices bottomed last May and have soared since then.  At the same time, the number of homes on the market consistently dropped until they bottomed in January.  Essentially, demand is so strong that it will take a major rise in listings to change the condition of the market significantly.    IMPLICATIONS:Is this a housing bubble?  In one sense, yes.  Demand is surging and the major factor driving it, a change in locational preference, is not likely to be able to sustain the current level of activity.  It is unclear how long the desire to escape to lower density locations will be sustained.  When workers start returning to offices, will that depress demand, and if so, by what magnitude?  The proportion of the workforce that will continue to work full-time or part-time remotely is simply unknown.  But to some extent, this locational shift will continue, as preferences are being re-evaluated.  So, demand should be sustained at a higher level than it would have been had the pandemic not hit.  That bodes well for sales and prices.  And it also implies that there will not be an implosion of the market.  The sales pace would have to fall sharply to bring supply and demand more closely together.  In addition, the sales surge is not being driven by financial sector excesses, such as no-down payments, 110% mortgages, no credit checks, ridiculously low teaser rates and make-believe appraisals.The people buying homes have the income and down paymentsas they are often trading one home for another.  And economic growth should remain strong through this year and while next year it may moderate, it is not expected to falter significantly.  So, while the market may be bubbling, it doesn’t appear to be in a bubble that is about to burst.  That doesn’t mean we will not see sales and prices fall.  They might, given how much they have risen.  But the slowdown, whenever it comes, is likely to be more controlled than panicky, which was the case when the last housing bubble exploded.

April Housing Starts

KEY DATA:  Starts: -9.5%; 1-Family: -13.4%; Multi-Family: -0.8%; Permits: +0.3%; 1-Family: -3.8%; Multi-Family: +8.9%

IN A NUTSHELL: “Home construction may have moderated in April, but with permit requests well above starts, the slowdown should turnaround quickly.”

WHAT IT MEANS:  The housing market is on fire, at least as far as prices are concerned.  As for home construction, that is a puzzle.  It was expected that housing starts would rise in April, even though the March level was already extremely high.  Instead, it dropped sharply, as single-family construction cratered.  Multi-family activity was down only modestly.  But the data were bizarre.  Starts were up in the Northeast and the West, but there was a massive 34.8% falloff in the Midwest and a large 11.5% drop in the South.  Why the declines were so large in the South and Midwest, I have no idea, other than to say we should wait to see what the May numbers look like.  And my guess is that construction will rebound sharply.  Permit requests remained robust in April and for the past three months, they have run, on average, about ten percent above starts.  Builders don’t pay for permits so they can sit around, so look for a construction to jump in the next few months.  Much of that, though, will likely be in multi-family units, as single-family permit requests are running just over two percent more than starts. 

Yesterday, the National Association of Home Builders released its May Housing Market Index and confidence remained at an extraordinarily high level.  It may have come down from the all-time high of 90 (out of 100) set last November, but that is misleading.  The May reading of 83 is eleven points above the high seen during the housing bubble.  The housing market is just fine.IMPLICATIONS:The issues facing housing is supply, or a lack thereof, and as a result, prices.  The number of homes under construction is rising minimally and the number of homes completed fell in April, so buyers will still have a tough time of it, especially since prices will likely continue to rise.  That is true for both the new and existing market.  In the new home segment, there is not only a shortfall of homes available to be purchased, but construction costs are surging.  A lack of labor and rising materials costs, when coupled with higher demand and rising mortgage rates is not good news for buyers.  This sector is an example of the problems with the global supply chain that have erupted since the pandemic hit.  The interdependence of suppliers across the world was put under tremendous pressure by the pandemic, which hit countries at different times and magnitudes.  A breakdown in multiple areas, coupled with the limited number of suppliers, has led to a massive shortage of a wide range of products.  On top of that there were trade barriers constructed and trade wars that further hurt the free flow of goods.  How long it will take to get the supply chain back to normal is anyone’s guess.  That is really troublesome as countries reopen and demand surges.  We are not talking about a normal rise in consumption and production, but a sudden acceleration.  Without the ability to ramp up supply, demand will continue to outstrip supplyand as every economics 101 professor will tell you, that means prices will rise.  That will likely continue until the supply chain is operating efficiently.  Since that is dependent on how long it takes for the pandemic to fade, it is impossible to put a time frame on it.  Investors need to start getting used to higher inflation, and while the Fed may not move anytime soon, market rates almost certainly will.

April Retail Sales, Industrial Production and Import and Export Prices

KEY DATA: Sales: 0%; Ex-Vehicles: -0.8%/ IP: +0.7%; Manufacturing: +0.4%/ Import Prices: +0.7%; NonFuel: +0.7%; Export Prices: +0.8%; Farm: +0.6%

IN A NUTSHELL: “Spending and production remain so strong that second quarter growth looks like it will be a lot stronger than the robust first quarter gain.”

WHAT IT MEANS:  Funny thing about having money to burn, if you got it, you spend it.  Yes, retail sales were flat in April and when you exclude the huge jump in vehicle purchases, they were down sharply.  But the total level of retail demand was as high as we have ever seen it.  It is just hard sometimes to keep spending more.  The details of the report were crazier than normal.  For example, apparel purchases dropped 5.1% and sales at general merchandise stores were off 4.9%.  Those are huge changes that are hard to explain.  Internet demand fell – really?  We did eat out and eat in, purchase more health products and appliances and electronics, but we cut back on furniture, sporting goods, and building materials.  Lower gasoline prices led to lower sales, but that gets wiped out when adjusted for costs. 

Industrial production was up solidly again in April.  Manufacturing activity increased moderately, but it would have been much better if the vehicle sector was not restrained by input supply issues.  Assemblies declined by nearly five percent even as demand jumped.  That caused durable goods output to fall.  Excluding vehicles, which is valid since the reduction was not due to demand, manufacturing would have increased by a strong 0.6%.  Nondurable goods production rose solidly.  If manufacturing stays flat from here, second quarter output would rise by 4.4%.  That is not likely to be the case, especially if assembly rates rebound.  Strong production gains going forward should power growth this quarter.

It’s broken record time.  Another price report, another set of rising prices.  Import prices surged in April even when you remove energy costs.  But the details are not quite as worrisome as the headline number.  Imported consumer product prices were flat and vehicle prices rose moderately.  But food costs surged again, as did the prices of industrial supplies and materials.  Producer prices should continue posted strong gains which undoubtedly, firms will try to pass along.  On the export side, U.S. firms, both farm and non-farm, were able to hike prices sharply.  IMPLICATIONS:The economy is growing strongly and there are no reasons to expect a major slowdown anytime soon.  Consumers and businesses are still being subsidized by the government and that will not change for a few more months.  So, there is little reason to worry about growth.  Indeed, estimates for second quarter GDP are being revised upward.  But that could be the high point, as the funds begin to run out in the third quarter.  Unless a new bill is passed, they will largely disappear in the fourth quarter.  That doesn’t mean we are headed for a downturn.  We still have a lot of reopening to go through and that will keep activity rising strongly, at least through the summer.  But for investors, it does raise the warning flag that the strong periods of growth may be coming to an end and the economy will start easing back toward trend growth.  What that means for the equity markets is unclear, as there appears to be little forward looking in the markets.  For the Fed, the hopes that the surge in inflation is transitory stems from the belief that trend growth will return soon, whatever soon means.But trend growth on top of robust growth could embed greater pricing power in the economy and that should concern the members.  Don’t be surprised if in the fall, the Fed’s inflation hawks, who have been hibernating, start shrieking again.  And they might have good reason to do so.

1st Quarter Productivity, Weekly Jobless Claims and April Layoff Announcements

KEY DATA:  Productivity: +5.4%; Hourly Compensation: +5.1%; Labor Costs: -0.3%/ Claims: -92,000/ Layoffs: 22,913

IN A NUTSHELL: “Businesses will have to keep improving productivity as the labor market is tightening faster as well.”

WHAT IT MEANS:  Tomorrow we get the government’s report on April job gains and it should be massive.  Despite hiring lots of workers, businesses managed to find a way to make them a lot more productive.  Productivity surged in the first quarter at the second fastest rate in eleven years.  The only time it increased faster was in the second quarter of last year, when the economy started opening up. But a year ago, hiring was muted.  Now, payrolls are booming, but so is productivity.  Businesses are getting a lot more out of their new workers, which they need to since compensation is also surging.  That has kept labor costs under control.  Hiring should remain strong through the summer, but don’t look for productivity to keep pace, so there is a risk that firms see their labor costs rise, further pressuring prices.

Indeed, the risk to businesses is that they cannot find enough workers and are forced to bid for them.  New unemployment claims dropped sharply last week.  With most states either already fully reopening or announcing plans to do so by summer, the improvement in the unemployment situation should continue unabated. 

Supporting the view of an ever-tightening labor market was the April Challenger, Gray and Christmas layoff announcement report.  The number fell and is now where it would likely be in a strong economy.  Firms are holding onto their workers tightly as they are having real problems replacing them if they leave.

IMPLICATIONS:  The good news is that job growth is strong and layoffs are falling significantly.  The bad news, for businesses but not for workers, is that the labor market is getting really tight.  A big problem is that over sixteen million workers are still receiving unemployment assistance.  With demand for workers skyrocketing but so many people finding it more beneficial to get a government check than a business paystub, the labor market tightening is not going away anytime soon.  The “shortage” of workers will likely remain extreme until the enhanced unemployment benefits run out in September.  But the high number of workers on special unemployment programs points out the problem that wages in a wide variety of sectors and professions are extremely low.  For many small business owners, the ability to raise wages is limited.  But they will have to.  For those who can, by raising starting salaries or wages, they are making the point that a higher worker minimum wage is affordable.  Actually, many have already put the minimum wage in the rear-view mirror.  The political debate over raising the minimum wage comes down to weighing the costs to those firms who cannot afford significantly higher labor costs against the reality that workers cannot live on the minimum wage or close to it.  The administration is on one side, the business sector is largely on the other.  With so many firms already starting workers well above the minimum, and many more being forced to due to market conditions, $7.25/hour seems like a strange number to be defending.  There should be a compromise that changes the status quo, but in this political environment, even logical actions become nonstarters.     

April Private Sector Jobs and NonManufacturing Activity

KEY DATA:  ADP: +742,000; Manufacturing: +55,000/ ISM (NonManufacturing): -1 point; Orders: -4 points; Employment: +1.6 points

IN A NUTSHELL: “The Friday jobs report should be another really big one.”

WHAT IT MEANS:  Firms, especially those in the hospitality sector, may be complaining that they cannot find workers, but hiring is not going to slow down anytime soon.  That should become clear on Friday, if ADP’s big private sector April estimate of job gains holds any water – and I think it does.  Private sector job gains should be robust, with increases across the board, both in terms of sectors and firm size.  Yes, leisure and hospitality are bringing back workers rapidly, but what was amazing to see is that manufacturing may be adding workers at the strongest pace in decades.  That is happening despite the shortage of computer chips.  The surge in home building is driving up construction payrolls and health care is hiring like crazy as well.  Basically, the job market is on fire.

We saw on Monday that the manufacturing sector is booming along and today the numbers indicate that the services component of the economy may be expanding even faster.  The Institute for Supply Management’s NonManufacturing index eased in April, but the level is still near the record high set in March.  Demand may be only booming instead of skyrocketing, but hiring is accelerating.  With backlogs rising and inventories shrinking, payrolls will have to increase even faster if firms are to meet their growing needs.  As we saw in the ISM manufacturing survey, input costs are jumping in the services and construction segment of the economy as well.  Nearly sixty percent of the respondents reported that the prices they pay for goods went up.  Those cost increases may get passed along if demand remains robust.     IMPLICATIONS:Almost every state has either fully reopened or announced when they would do so.  Over the next few months, most people who want a job should have a chance to get one.  The only thing that would limit the increase in payrolls is the that the government is paying more to be on the unemployment rolls than the private sector is paying to work at their businesses.  The choice is clear, at least until the enhanced benefits run out.  Nevertheless, employment should growth massively well into the summer and that would generate large gains in wages and salaries.  So, look for retail sales to be robust into the fall, as people celebrate the return to some measure of normalcy.  We are already seeing that as April vehicle sales increased sharply. As for investors, their exuberance should be sustained.  Second quarter growth could match or even exceed the robust 6.4% pace posted in the first quarter, meaning earnings should be strong as well.  And the government will continue pumping money into the economy.  While some sectors and individual stocks may be priced quite high, there appears to be no economic reason for a major pull back in the general market.  But don’t be surprised if there are some price adjustments, as this market has been out of control for a while now. 

Linking the Economic Environment to Your Business Strategy