September Labor Market Data will Dominate the Week

Financial markets took a breather last week after enduring one of the worst weeks for economic data (relative to raised expectations) in many months. Reports on durable goods orders, home sales, leading indicators and consumer sentiment data all came in at or below expectations. Overlooked in the week, however, may have been the better news on the labor market in September, as jobless claims fell again and the employment components of both the Richmond and Kansas City Federal Reserve surveys indicating that the labor market continued to improve in September.

The Federal Open Market Committee (FOMC), the Federal Reserve’s policy-making arm, also chimed in last week. While the FOMC left its key policy rate unchanged, it did begin to prepare the markets for the eventual removal of monetary policy stimulus. Any change in language by the Fed was incremental however, and we still don’t expect the Fed to begin raising rates until the middle of 2010.

This week is chock-full of data, as market participants continue to firm up their views of economic growth in Q3 2009. The consensus is looking for a 2.9% gain in real gross domestic product (GDP) in Q3 2009, which would mark the first quarter of positive GDP growth since Q2 2008. In our previously published 2009 Outlook, our estimate for growth in the second half of 2009 was 2.0 to 3.0%. Based on the data in hand, that estimate is probably too low. We now expect Q3 2009 GDP growth to be closer to 4.0%, with 3.0% growth likely in Q4.

Looking out into 2010, the consensus is looking for the economy to grow at only a 2.4% pace. The high estimate for real GDP growth in 2010 among the 75 economists surveyed by Bloomberg is only 4.0%. The average growth rate for the U.S. economy during the first year of a recovery is 6.5%. To put that into perspective, the average gain in real GDP during the first year of recovery after the mild 1990-91 and 2001 recessions was 2.3%. Thus, the consensus is currently forecasting that the recovery next year from the longest and deepest recession since the 1930s will be the same as the recovery from the very mild recessions in the early 1990s and early 2000s. Our view is that the forecasts for economic growth for 2010 are too low, and this week’s full slate of economic data is likely to begin moving the consensus forecast for GDP growth in 2010 higher.

The Week Ahead

The section below provides some observations on this week’s key economic releases. Alongside the preview are questions that markets, the media and, yes, economists are likely to be asking as the data is released.

September Chicago Purchasing Managers Index (Wednesday, September 30)

• The market will be looking for signs in this report that business capital spending is poised to help lead the economy out of recession.

• Until it hit 50 in August, the Chicago Area PMI has been below 50 since October 2008, indicating that the manufacturing economy in the Chicago area is contracting.

• The key new orders component, a good predictor of future manufacturing activity in the region, pushed above 50 in August, indicating that manufacturers’ orders were expanding for the first time since September 2008.

September Employment Data (released throughout the week)

• The employment components of the Chicago Area and national ISM reports, due out on Wednesday, September 30, and Thursday, October 1, will provide an early window into Friday’s nonfarm payroll report. The employment components of several of the regional Federal Reserve Banks (Kansas City and Richmond) for September already indicate that hiring in the manufacturing sector has resumed.

• Through the worst of the recession in late 2008 and early 2009 the ADP employment report (Wednesday, September 30), provided a fairly reliable “early read” on the overall national employment report, as it accurately predicted the direction and magnitude of the job losses. In recent months, however, the ADP report has had a spotty track record, overestimating the number of jobs lost relative to the national report in each of the past four months. The market is looking for a 200,000 drop in private sector jobs in September, following a 298,000 drop in August.

• The Challenger job cut (Thursday, October 1) data has been a good leading indicator of the labor market in 2009, peaking in January of 2009, roughly two to three months before jobless claims peaked in late March. Layoff announcements fell between July and August, and were down sharply (14%) from a year ago (August 2008). The market would be comforted by another drop in layoff announcements in September.
  

• As September turns into October, the weekly jobless claims data (Thursday, October 1) have now been free of the auto related distortions for several months now. At 553,500 the four-week average on jobless claims stands more than 100,000 below its peak of 658,000, reached in late March 2009. The claims data are clearly signaling that the recession is over. However, the market will be watching the pace of decline in jobless claims closely over the next few weeks, as it tries to gauge whether or not the economy is in for another “jobless recovery”.

• The market expects the September jobs report (Friday, October 2) to show a slower pace of job losses in September versus August. Consensus is looking for a 180,000 drop in payrolls in September versus the 216,000 drop in August. If the consensus is correct, the pace of job loss in August would be the slowest since August 2008. The “late” Labor Day in 2009 (Labor Day fell on the latest possible date this year, September 8) could introduce some additional “noise” into the report.
  

• We expect the pace of job losses to slow over the next several months and into year end 2009; we don’t expect the economy to begin to create new jobs on a sustained basis until late 2009/early 2010.

• The consensus is looking for the unemployment rate to tick up to 9.8% in September from 9.7% in August. The market was caught off guard last month when the unemployment rate unexpectedly jumped 0.3% to 9.7% in August from 9.4% in July. In the prior month, the unemployment rate unexpectedly fell from 9.5% in June to 9.4% in July. The drop in the unemployment rate between June and July called into question the view that the unemployment rate would peak at over 10.0%. We point out that the unemployment rate often “wobbles” around—moving up or down 0.1%—at turning points in the economy. It wobbled down in July but wobbled up in August. We think the wobbling will continue, but that the unemployment rate is probably headed to 10.0% by year end.

September ISM (Thursday, October 1)

• The ISM index of manufacturing has been above the key 41.2 level since May 2009, indicating that while the manufacturing sector was still contracting, the overall economy was expanding.

• In August, the ISM finally pushed above the 50 mark, indicating that the manufacturing sector was expanding. Augusts’ 52.9 reading marked the first time the index had been above 50 since January 2008, and was the highest reading since June 2007.

• With the “Is the recession over?” question now largely moot, the question the market is asking now is “how strong will the recovery be?” An ISM reading above 60 in September would be an important data point in confirming that the initial stages of the recovery may be stronger than expected.

• Along with the employment sub index within the ISM report, the new orders index will be of interest to the market looking for forward looking information. The new orders series pushed above 50 in July to 55.3, and pushed up to 64.9 in August, marking the first time the new orders series was above 50 on a consistent basis since mid to late 2007.

• Assuming the recession ended in June, through August, the new orders component of the ISM has risen faster in this recovery than it has in any of the prior five recessions dating back to 1970.
  

September Vehicle sales (Thursday, October 1)

• The September vehicle sales report can be summed up in six words: The hangover from cash for clunkers. Vehicle sales are expected to slip back to a 9.5 million annualized rate in September after surging to a 14.1 million pace in August on the back of the cash for clunkers program.

• The real question is what happens to vehicle sales in September? Do vehicle sales fall back to the tepid 9.0 million pace seen earlier this year? Or will the nascent economic recovery keep sales humming along at a 13.0 million annualized pace? The most likely outcome is somewhere in between the two. Recall that vehicle sales were running at a 15 to 16 million pace prior to the onset of the recession in late 2007.

• In either case, auto production probably needs to increase noticeably over the final months of 2009 to help replenish inventories depleted by cash for clunkers.

August Construction Spending (Thursday, October 1)

• The market is looking for more evidence that a definitive bottom has been made in the residential housing market.

• Can the stabilization in residential construction offset the ongoing pain in private non-residential construction (malls, shopping centers, office parks, industrial facilities), which are being impacted by the lack of financing available to developers?

• Public construction spending is being impacted by the infrastructure component of the $787 billion fiscal stimulus package. During the Q2 earnings reporting season, several industrial and heavy machinery companies cited the infrastructure portion of the fiscal stimulus package as a reason for an unexpected uptick in orders and new business. We expect the same type of news in the upcoming Q3 earnings reporting season.

• Only about $86 billion of the expected $250 to $300 billion of the infrastructure funds have been spent through mid September, so the full impact on the construction data has yet to be felt