A Two Speed Economy

The conundrum facing the Fed when raising rates

The rationale for raising interest rates has been somewhat of a moving target for the Fed over the past 3 years.  At first it seemed as though 6% unemployment was the threshold requirement.  Once this level was attained, attention shifted to a 2% inflation target, with a particular focus on wage inflation.

Although inflation has been persistently short of the 2% level, significant near term upticks in wages may have pressured the FED into their December 16th, 2015 rate hike.  The Bureau of Labor Statistics (BLS) average hourly earnings for December indicate a year over year increase of 2.5%.

Moreover BLS compensation per hour numbers (a measure of gross wages, benefits and exercised stock options) came out at a 3.6% increase year over year for Q3, 2015.  These are up from a revised 3.2% in Q2 (raised from the prior 2.2% estimate), a further increase from only 1.5% year over year in Q1, 2015.

Accordingly these numbers indicate that wages and benefits are accelerating and the consumer appears to be in good shape.  Since the consumer represents around 70% of US GDP the strength of this segment should insure that the economy can continue to grow (albeit slowly) at around 2%.

The jobs numbers paint a similar picture.  The Labor Department’s payroll number for December showed the economy added 292,000 workers, exceeding the highest estimate in a Bloomberg survey.  Furthermore November’s payrolls were revised higher to 252,000 from a previous estimate of 211,000.  Since 1999, there has been only one year in which more workers were hired.

In November’s ADP Employment Report, companies which employ 500-999 employees had the largest increase ever reported in the history of ADP keeping numbers. The service sector was the source of the largest increase with 204,000 new jobs which contrasts with an upwardly revised number in October of 174,000.

However, not all sectors of the economy have a resoundingly positive trajectory.  This is particularly the case for manufacturing which paints a decidedly different picture.  November’s ADP Employment Report indicates that manufacturing sector added just 6,000 jobs.  While small, this reverses the trend from the losses registered in the prior two months.

The ISM chart below underscores this point, with manufacturing experiencing a significant slowdown since September 2014 with the rest of the economy consistently within a narrow range in growth territory.  Accordingly it looks as though we have a two speed economy with consumers doing fine and manufacturing flirting with recession.