The decline in this month’s ISM manufacturing index draws into sharp focus the key impediment to the US Federal Reserve continuing to increase policy rates in the coming months – economic growth is clearly losing momentum and this will create fewer jobs.
With employment growth a key plank of the Fed’s remit, a below-par jobs market expansion is likely to restrict the FOMC to just two more quarter-point moves with rates then unchanged at 3.50 per cent for some time.
This view, that the rate hike cycle would encounter an employment blockage by the middle of this year, now seems to be fully reflected in bond market pricing. In that sense (and drawing parallels with our UK interest rate view) there is now little to be gained in a market sense from holding that forecast.
Aside from the weak ISM, Treasuries were given a bit more to go for this week with some indication being given by Dallas Fed President Fisher that the FOMC may be close to having done enough on rates (albeit via a convoluted baseball analogy which also managed to intimate that inflation might still be an upward risk – to our minds this was merely a clumsy attempt at finding an ‘on-the-other-hand’ statement to counter any bullish message on rates he may have unintentionally fostered).
Disappointing leads
Amid such disappointing US lead indicators, the prospects for this month’s non-farm payroll release seem fairly bleak. The main business cycle indicators are consistent with a fairly sizeable pullback from last month’s 274k increase.
But if ever there is an indicator release to burn the fingers it is the monthly employment report. We discussed last month how the accounting procedure for five-week Aprils had an apparent tendency to add around 100,000 to the monthly payroll change.
This highly unscientific approach to forecasting almost paid off with the actual release closer to our own guess of 200k than the consensus for 174k.
This month, despite the clear downward tendency of the ISM pointing to softer payrolls ahead, we think it is too soon to get too gloomy.
The broad span of employment market indicators, from hours worked to jobless claims, are consistent with actual labour demand having remained largely unchanged in recent months.
The pseudo-scientific rule this month says that May payrolls that follow five week Aprils have tended to come in a good 60k above the Q1 average change – this would deliver a figure today of around 250k.
Fudged forecast
But adjusting for the fact that we are in a downward trend, and that there were apparently some difficulties in adjusting the data for April’s missing Easter Holiday, we come up with a fudged forecast this month of 200k.
The consensus is for 175k. Perhaps the most pertinent NFP forecasting signal of all though is that our call has been more accurate than consensus for the past three consecutive months.
This is highly unlikely to persist. For the market an upward surprise would only really be relevant in the short-term. For the economy, the situation remains one of an enduring slowdown through the second half of this year.
Key developments
· The UK housing market continues to render itself of secondary importance to the MPC’s near-term rate deliberations by easing back rather than collapsing. The Halifax measure of house price inflation rose by 0.3 per cent month-on-month in April after a 0.9 per cent increase in March. After declining sharply through the second half of last year, house price growth has stabilised at an average 0.2 per cent monthly rate of growth – an annualised rate of 2.4 per cent year-on-year (compared with annualised growth of 27 per cent at the start of 2004). Uppermost in the MPC’s mind is likely to be assessing the extent of the demand slippage that has taken place in recent months as consumer spending growth has slowed and manufacturing activity has gone into reverse (this month’s PMI dropped to 47.3 from 49.1 a month earlier – its lowest in two years). It is worth pointing out, though, that some of the weak manufacturing survey data can be attributed to the collapse of MG Rover so the Bank are likely to be cautious not to over-interpret the decline. Our UK rate forecast remains unchanged – we see a rate cut to 4.5 per cent towards the end of the year.
· The French and Dutch rejection of the EU Constitution has clearly dominated the media and, to a lesser extent, financial market attention in recent days. At the sharp end is the price of the euro on the foreign exchanges, which has dropped to 1.22 versus the dollar in the past week – its lowest since October last year. But this needs to be put into context. The average euro/dollar exchange rate over the course of 2004 was 1.24 (and the previous year’s average was 1.13). In that respect, these recent moves are pretty small and will be of no concern to the ECB.
· A more esoteric upshot of the Constitution rejection is one which sees questions raised over the sustainability of the entire euro project. The fact that two of the founding members of the EU have rejected a key element of the Union’s platform for the future, coinciding with the broader examination of the extent to which some member states’ (especially Italy’s) efforts to boost competitiveness are restricted by being in a currency union, may be enough to encourage the financial community to conduct a cost-benefit analysis for certain countries of staying in or getting out.
Steven Andrew is an economist at F&C Asset Management plc
