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This week’s US data seem to have enhanced the market’s confidence that the Fed tapering process will begin sooner rather than later. Signs of strength in the labour market, coupled with a modest increase in inflationary pressures, arguably go some way to validating the Fed’s intentions. In the UK, unemployment is now the new inflation for monetary policy decisions; labour data released this week seem to be confirming our view that the threshold for rates may be met sooner than the MPC currently anticipate. Finally, we briefly add to our initial comments on the latest positive Euro area quarterly GDP data: while unambiguously good news, our view remains that we are still a long way from a sustainable recovery.
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US – Jobless claims bring the taper closer
This week brought further signs of improvement in the all-important US jobs market as data from the Department of Labour showed that the level of initial jobless claims fell to 320k in the week-ending 10 August. That was the lowest reading since September 2007, three months before the recession hit. As our first chart shows, the flow of newly unemployed fell quite sharply through July. Moreover, and perhaps just as importantly, continuing claims are also on a clear downward path. Hence, the average duration of US unemployment, which had reached an unprecedentedly high peak of 25 weeks, has fallen to a median of just over 15 weeks. The bottom line is that we are making good progress towards the assumed threshold for US tapering of an unemployment rate of 6.5%-7%.
Government drag on payrolls easing – payrolls forecast tops 200k
Our claims model of non-farm payrolls combines the level of initial claims with the change in continuing claims to forecast monthly changes in employment. The continuing claims series is volatile from week to week, but for the past three months or so it has recorded falls of around 20k per month. According to our model this, together with a level of initial claims close to 320k, should return monthly gains in non-farm payrolls in the region of 240k. As our chart shows, private sector job creation has been consistent and robust for several years now – the level of private sector employment is some 6pp above its previous peak. But the key swing factor in driving the headline number higher is the easing of the drag from falling public sector jobs.
Although fluctuations in both participation and the household survey measure of employment will complicate the picture, if sustained this will put significant downward pressure on the headline unemployment rate. This picture of a strengthening labour market, against a backdrop of gently rising inflation, with the core CPI measure rising to 1.7% in July, may just give the balance of FOMC members sufficient confidence to begin the tapering process when they meet towards the end of September.
UK – unemployment takes centre stage
Following the forward guidance set out by the MPC, labour market data have taken on an importance in the UK like that of Non-Farm Payrolls in America. Unemployment is the new inflation for monetary policy decisions. Data released this week painted a positive picture of developments in the labour market, unemployment fell while employment and hours worked rose marginally further above their previous peak.
The headline unemployment rate covering the period from April to June, was unchanged at 7.8%. This means that the Bank of England has already experienced an ‘upside’ surprise because Bank staff were anticipating the unemployment rate to be 7.9% in Q2. The MPC is focused on the LFS measure of unemployment, but the more timely claimant-count often leads the way for the broader measure, and it fell to its lowest level since February 2009 in July.
It is often claimed that the LFS measure is a more reliable indicator of labour market conditions, which is true. But it is very far from perfect. The ONS now release figures for individual months, which as our chart shows are extremely volatile. So much so that they are not classified as National Statistics by the ONS! Another reason for the ONS’s doubts might be the steady decline in the average response rate to its survey – a decade ago it stood at around 80% of respondents, but today it is less than 60%. Still, that is what monetary policy in the UK is now pegged to. And while volatile, the data nonetheless showed a fall in the unemployment rate in June to 7.4%. As an illustrative point, if the rate were to remain at 7.4% for the next two months, this would mean that the MPC would already be halfway to its threshold for rates and asset purchases (7.0%). This adds weight to the growing view in the market, which we share, which is that the threshold for rates may be met sooner than the MPC currently anticipates. In our view, this is because productivity will not rebound the way in which the MPC expects it to.
Signs of rebalancing welcome, but still a long way for the all-clear in the Euro crisis
After six consecutive quarters of contraction, the Euro area economy recorded growth of 0.3% in Q2. The recovery was broad-based, with all countries for which data are available registering an improvement. Although this is certainly welcome news, we do not think it merits confidence in either a lasting recovery or a beginning of the end of the Euro crisis. This is because although the rebound was broad-based, the degree of rebalancing evident in the data was limited, and importantly structural fundamental impediments to growth remain very much in place.
The main contributors to growth in Q2 were Germany and France, which expanded by 0.7% and 0.5%, respectively. Importantly, it does seem that domestic demand was a positive contributor for both countries—especially France. At the same time, although official data are not yet available, it appears that net trade made a positive contribution to both Italian and Spanish growth. So there is tentative evidence of some rebalancing going on between core and periphery. However, Italian customs statistics show a fall in imports of 2.1% in Q2 and an increase in exports of just 0.4%, while Bank of Spain forecasts suggest the country’s net exports contributed 0.4 percentage points to growth in Q2.
Hence we need to be careful in extrapolating these trends. It is clearly a positive development that, following a period of stringent fiscal austerity, most peripheral countries’ competitiveness has markedly improved in absolute terms, as well as relative to Germany. However, a lasting recovery in the periphery will require not only a progressively higher contribution to growth from net trade, but one that is of the right kind—in other words, one built on rising exports rather than collapsing imports. And that, conversely, will require much stronger import demand form the core, and in particular, Germany.
Hence, the main structural factors that have been hampering the Euro area remain largely unaddressed. In particular, broad internal current account imbalances still persist. Moreover, while the dollar’s rise and the euro’s subsequent fall is welcome, the spill-over from rising US bond yields is a cause for concern. Debt sustainability issues have not abated and a genuine, full banking union remains out of reach. These not only have a negative impact on the over-indebted peripherals, but could also induce a sense of uncertainty that could hold back domestic demand—especially investment—in the core countries.
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