Article / 02 August 2016 at 23:14 GMT

Drilling down into America's sedulous economy

Managing Partner / Spotlight Group
United Kingdom
  • Jobs data this Friday is a key focus, but other data points are just as revealing
  • Exports are being squeezed by the strong US dollar
  • Productivity is key, so next Tuesday's data is economically more significant

By Stephen Pope

This Friday, August 5, will see the employment data for July released by the US Bureau of Labor Statistics. The expectations are as follows:
Data exp

Source: BLS and Street Estimates 

This sequence of statistics is arguably the most important single data release of any month within the US and maybe the global economic calendar. So it is natural that much will be made about the numbers when they are released at 0830 EST (1230 GMT). The markets will undoubtedly experience a convulsion or two as bond yields and equity futures rise and fall in the first few moments of data aftermath.

However, there are other economic metrics that can offer a useful profile for the state of the world’s leading economy, some may look encouraging, but just around the corner, danger awaits.

 US jobs numbers are arguably the most important data release of any month. Photo iStock 

GDP data can be misleading

There was a genuine sense of concern when it was reported by the Bureau of Economic Analysis that Q2 GDP in the US expanded by 1.20% over the same quarter of the previous year. This was well below the 2.5% analysts had forecast. The undershoot was seen as being almost entirely due to a contraction in wholesale inventories.

Optimists will gleefully point to the fact that if one were to strip out inventories and simply focus on net final sales then in Q2 the growth was actually 2.4%. That would represent a healthy rebound from the winter and they will claim that final sales are a superior measure of the underlying rate of growth as inventories can fluctuate and do not always mirror the long-term trend.

But don’t write it off that quickly. If companies are not maintaining their inventory balance it implies they are losing a degree of confidence in the future. They do not wish to have too much working capital tied up in unsold stock if uncertain economic times lie ahead.

Consumers are spending ...

The largest single component of the US economy is personal consumption expenditure. It expanded at an impressive 4.2% rate in Q2, which has been cited as proof positive that the improving labour market and lower fuel prices have finally translated into a long-awaited boost in consumer spending. The base of expenditure is broad as it has been felt in retail stores, restaurants and automobile dealerships. Indeed, for H1 2016, total retail sales were up 3.1% over the same period of 2015.

... as wage growth accelerates

The employment cost index (ECI) does not always receive as much attention as GDP or the unemployment rate, however, it is a critical data point for understanding what employers are spending on employee pay and benefits. This is crucial as wages and salaries comprise approximately 70% of compensation costs, which in turn are between 45% and 50% of US employers' total costs.

The ECI gained 0.6% in Q2 and over the previous year it gained 2.3%. However, dig into the detail and one will discover that the earnings (wages and salary) component of compensation is now up 2.5% over the last year and 2.0% in Q2.

This suggests that take-home remuneration is starting to rise at a faster pace and it is in net cash compensation. It is not put into the pay packet only to be taken out again by health insurance and other employer-provided benefits.

Four pictures
Source: Bureau of Economic Analysis, Census Bureau, Bureau of Labor Statistics

Not all is so delightful

The apparent rosy picture above has to be tempered by the fact that investment in business structures, equipment and intellectual property fell for a third consecutive quarter.

The decline in energy prices has seen a cutback in investment for energy exploration and the strong level of the US dollar (up 19% since June 30, 2014) is squeezing US American exporters.
At Princeton University, Hooper, Johnson and Marquez estimated that the US export price elasticity is down 1.5%. That means for every 1% the dollar gains in value, exports fall by 1.5%. Since the end of June 2014, i.e. over 25 months, US exports will have fallen by 28.5%.

Given that this represents a severe compression of top line earnings one has to question how long the boost in the ECI can be maintained? After all, do not forget that profit = revenue – costs. The squeeze on the bottom line as revenue falls and costs rise will not be tolerated for too long by aggressive equity traders.

The fact is that a great deal of faith is being placed in the US consumer keeping up the current pace of expenditure; the underlying worry is that the economy appears to drifting away from its optimal dynamic position of steady growth, low inflation and full employment.

Growing consumer expenditure requires business inventory expansion and investment. If the level of business investment does not improve and ECI itself is cut, we may well see a stall in the economy as consumers slow down their expenditure, which will feed through to a rise in unemployment.

 The strong US dollar is squeezing US American exporters. Photo: iStock

Productivity growth is poor

Productivity in the nonfarm business sector in the US decreased at a seasonally adjusted annual rate of 0.6% QoQ in Q1 2016. This was lower than preliminary estimates of a 1.0% decline and a 1.7% fall in the previous period, final figures from the Bureau of Labor Statistics showed.

Output increased 0.9%, higher than earlier estimates of 0.4% and hours worked went up 1.5%, in line with preliminary figures.
Source: Bureau of Labor Statistics

Over time, it is worker productivity that determines the wealth of an economy and in the US this figure has been disappointing for several years and the latest data suggest it will turn out to be even worse than that in H1 2016. New data to be released on August 9 will probably continue to tell a gloomy story even if the forecast of 0.9% is better than the Q1 data.

What drives productivity is poorly understood. In the neoclassical view, exogenous technical progress drives long-run productivity growth since broadly defined capital suffers from diminishing returns. In contrast, the new growth models yield long-run growth endogenously, either by avoiding diminishing returns to capital or by explaining technical progress internally.

Needless to say, the competing models imply that economists, both academic and financial, cannot readily agree on the causes of productivity growth and as such any problem in this area is not rescued by one simple solution. The Fed cannot cut rates and see productivity scoot higher immediately. There are considerable lags and many other factors based around business confidence have to be factored in.

However, what may be true this time is that more interesting from an economic and market perspective will be the data to be released at 0830 EST next Tuesday as against the noisy data this Friday.

– Edited by Gayle Bryant

Stephen Pope is managing partner at Spotlight Ideas. Follow Stephen or post your comment below to engage with Saxo Bank's social trading platform.
03 August
BuySellBuySell BuySellBuySell
Great article Stephen! Thanks.
03 August
Stephen Pope Stephen Pope
Thank you for your kind comments "BuySellBuySell"


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