U.S. Employment: Trust The Data

Today’s payroll report, combined with the ISM reports, suggests that the U.S economy is back on track after a weak start to the year.

US Employment - Trust The Data

The labor data and ISM surveys paint a much more upbeat picture than other recent economic releases on the demand side (notably, consumer spending reports). Which is telling the right story? Our bias is that today’s payroll report is a good reflection of the current state of the U.S. economy.

The ISM data is relatively free of revisions, and the BLS payroll data is generally considered to be of higher quality than other official statistics.

At 288 000 monthly payrolls in June, and upward revisions to previous months, the job market is on a decent – albeit not stellar – trajectory. The main positive points in the report are that the employment gains are broad-based across sectors; there were notable gains in “high-quality” jobs such as financial services, and other professional and business services; and the unemployment rate fell on the back of a flat participation rate (i.e. not for structural reasons).

On the latter point, the Fed’s estimate of NAIRU sits at 5.3%. Therefore, with a current unemployment rate of 6.1%, there is still a sizeable gap before the economy hits full employment and sustainable wage inflation takes hold. The Fed is unlikely to feel much pressure to warn of premature rate normalization, but the steady decline in the unemployment rate nonetheless serves as a reminder that the ZIRP era is coming to an end. Stay tuned.

Update On Gold

Gold prices remain trendless.

Update On Gold

Our Commodity strategists expect to maintain an underweight precious metals position within the commodity complex. The above chart shows that the key drivers of gold since 2008 – real interest rates, the dollar and investor risk aversion, proxied by the U.S. equity risk premium – have stabilized. Our view is that these drivers will remain trendless in 2014H2, although an equity correction could cause an intermediate-term shift. However, ETF volumes already have adjusted downward, minimizing any downside for gold (and silver).

What could make us wrong and begin a gold bull market? Ironically, a growth scare rather than an inflation scare is the most likely candidate. It would put pressure on central banks to boost liquidity “at any cost”, just like in 2008-2011. But we view that probability as unlikely.

Bottom Line: Gold will ebb and flow with the dollar against a flat trend.

A U.S. Recession Is Unlikely

The annualized 2.9% contraction in first quarter U.S. GDP was among the worst of the postwar era and the only one of its size that did not occur during a recession. But coincident and leading indicators suggest that a recession is highly unlikely.

A US Recession Is Unlikely

From the coincident perspective, the pickup in the pace of hiring, modest as it has been, contrasts with the deceleration of payroll gains that have regularly preceded recessions. Year-over-year movement in the leading economic indicator has been a solid recession predictor, and it is nowhere near contraction territory now. Stocks agree, as they typically begin to lose ground in the latter stages of expansions, and there has been no sign of the overheating in cyclical segments that typically precedes recessions.

Looking through three-month-old GDP data from the first quarter would therefore seem to be the right investment approach.

The silver lining for investors is that soft growth will preserve accommodative policy settings. As long as recession is avoided, any pullback in stock prices should be viewed as a correction, not the end of the bull market.

The BoE Turns Hawkish?

Hawkish comments from BoE Governor Carney gave sterling a boost late last week. However, the BoE will use macro-prudential policies to cool the housing market before resorting to interest rate hikes.

The BoE Turns Hawkish

At his annual Mansion House speech, Chancellor Osborne pledged to give the BoE greater powers to regulate mortgage lending in order to remove the froth from the housing market. This would entail setting limits on loan-to-value and loan-to-income ratios to discourage excessive borrowing.

Despite being given new policy levers, BoE Governor Carney also warned that he could raise rates sooner than the markets currently expect (which was April 2015). Not surprisingly, sterling reacted positively to Carney’s comments.

Our FX strategists think it is premature to conclude that a BoE tightening cycle is imminent. While the housing market is hot, the economic recovery in the U.K. is unbalanced and inflationary pressures are muted. For example, the trade deficit is at record levels and industrial production, while up from the lows, remains 12% below the pre-crisis peak. Meanwhile, CPI inflation is back below the BoE’s 2% target and wages ex-bonuses are rising by just 0.9% yoy.

Bottom Line: The BoE will use macro-prudential policies to cool the housing market before resorting to interest rate hikes. Our F/X strategists recommend staying out of the sterling market for now.

CRE: In A Sweet Spot

Commercial real estate (CRE) is in an expansion phase, backed by favorable global economic trends.

One of the main factors that will support CRE markets globally is the return of growth. The major economies are expanding in a synchronized, if uneven, fashion. This renewed growth impetus has already begun to spill over into CRE expected returns. Like regional growth patterns, the recovery is uneven across property markets as the transition in demand from safety to growth plays out. In times of uncertainty, the trophy markets are sought for a safe and liquid income stream, but during good times, the fundamentals of the non-trophy CRE properties improve with the economy.

Another important driver for CRE is that the demand for safe havens is clearly a thing of past, with gold prices having peaked in 2011. Receding risk-aversion means that interest in riskier assets will once again fuel demand for real estate.

CRE In A Sweet Spot

The third and perhaps most important support for CRE is its link to the monetary policy cycle. Currently, easy money supports rental growth similar to how it stimulates economic activity. Eventually, tighter monetary policy will challenge returns through the higher cost of borrowing and tighter risk premia. However, real estate’s underlying link to growth shelters it, to some extent, from the early phases of monetary policy normalization as the onset of the tightening cycle coincides with an acceleration in economic activity. In other words, real estate’s net-operating income growth (NOI) typically tracks the Fed cycle. The Fed will only tighten policy in the face of accelerating growth, which should coincide with rental growth through increased tenant activity. Therefore, as the case for easy money fades, growth will support real estate returns and compensate for rate hikes in the initial phases of the tightening cycle.

Bottom Line: CRE is in a sweet spot with global growth recovering, investors’ risk appetite rising, and monetary policy supporting CRE’s return drivers. In the U.S., our CRE strategists suggest focusing on economically-sensitive non-major markets with high exposure to technology and industrials.