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DailyFX Special Report: It All Depends On Jobs …..
Published Date: March 26, 2004
Given that the dollar has rallied 6% against the euro in the past 5 weeks, it is inevitable that the market would begin to talk about a dollar reversal. However, the talk remains restrained and cautious, as the market is still not completely convinced that fundamentals have shifted enough to warrant a broad based shift in trend. So what are we waiting for?
With 8.2% and 4.1% GDP growth in the third and fourth quarter respectively, there are no doubts that the economic recovery is underway. However, a quick survey of the market will lead many to think otherwise. The dollar is weak, the Dow has tumbled since the beginning of the year, while the outlook for hiring is still discouraging. If the economy is truly booming, the labor market would be healthy, equities would be rallying and foreigners would be pouring money into the US asset markets, helping to boost the value of the dollar. Unfortunately this is not the case. The current state of the US economy and the dollar is best described as a coiled spring - kept retracted as it looks for its next catalyst. The economic spring is kept coiled by one factor - the labor market. Until we see more evidence of a strong pickup in job creation, the economy and the US dollar will have a difficult time springing out of its restrained state. The health of the labor market and its future prospect are heatedly debated in the press. This makes jobs the number one factor that can change perception. If payrolls suddenly take off, this could rattle the markets, sending equities higher, bond yields soaring and the dollar rallying. Whether or not you believe that this will happen depends upon which side of the table you are sitting on - that is if you are a labor market bear or bull. Here are where the bears and bulls stand - take your pick:
· Labor Market Bears - With over 2 million jobs lost since Bush took office, if the labor market does not rebound, the economic recovery will be threatened.
· Labor Market Bulls - The payrolls data is distorting, the economic recovery is being led by the spending habits of the 94.4% employed so once productivity declines, corporations will be forced to hire.
Labor market bears - With 8.2 million people out of work as of February, it is not surprising that most Americans are very disappointed about the current state of the labor market. Nearly a fourth of these workers have also been out of work for six months or longer, indicating rising discontent. The papers have been littered with articles on the labor market - most of which reflect the views of labor market bears. Sentiment has worsened further following the release of the latest non-farm payrolls report for the month February, which indicated that only a dismal 21,000 jobs were added onto corporate payrolls last month. Although the unemployment rate declined to 5.6%, the plunge was not a result of an increase in the number of employed individuals, but rather reflects 392,000 people exiting the labor force. Since March of 2001, labor market participation has declined 1.2%. It is estimated that in order to get the share of people employed back to the level seen at the trough of the recession, (also factoring population growth) the economy would need to add 260,000 jobs per month for the next twelve months. Furthermore, unprecedented stimulus from the government has kept joblessness artificially low. This includes a significant amount of government spending, especially on defense and homeland security. The February labor market report is clear evidence of this artificial stimulus, as all of the jobs added onto payrolls were government and not private sector jobs. At this rate, payroll growth is clearly going to fall short of that target. So far, the manufacturing sector has been the worst hit, as February marked the 43rd consecutive month of manufacturing job losses. Labor market bears find that generous fiscal stimulus cannot continue forever. Once fiscal stimulus slows, the labor markets and the economy may take a hit. This is particularly concerning since the difficulty of finding jobs will eventually force consumers to cut back spending and increase savings, which they believe would ultimately threaten the sustainability of the US economic recovery.
Labor market bulls - Not everyone believes in the dismal jobs picture painted by the press - including Fed Chairman Alan Greenspan and US Treasury Secretary John Snow. Despite the weak payrolls growth in February, Greenspan has not wavered from his forecast that a significant pickup in hiring is expected to occur in the very near future. Many labor market bears wonder where this growth will come from and according to Greenspan, a slowdown in productivity will eventually prompt firms to increase hiring. Some even believe that the overcapacity left over from the bubble years of the 1990s has sheltered the economy and many businesses from what would have otherwise been a more painful downturn. In the 90s, unrealistic amounts of venture capital investments, junk bond financing and proceeds from IPOs have left US companies with excessive amounts money for plants, equipment and people. Typically the economy would have worked off the overcapacity in a shorter period of time, but these excess proceeds have kept many laggards in business. Also, with interest rates at such low levels, corporations have found it more attractive to increase capital investment over hiring - once this peaks, firms will be forced to hire. Although recent surveys of the manufacturing sector suggest that firms expect to increase hiring over the next few months, businesses have been reluctant to hire until they are completely confident in the recovery. Firms will want to delay hiring until they are sure that they will not have to conduct layoffs shortly thereafter. Therefore these firms instead have opted to hire temporary workers and/or independent contractors. This is actually the second most popular argument of labor market bulls, particularly that of John Snow. He is frequently quoted as criticizing the payrolls data for failing to account for the significant increase in number of self-employed individuals and independent contractors. According to the Labor Department, nonfarm self-employment as measured by the household survey has risen 7.3% since the recession ended in November 2001. This equates to an increase of approximately 644,000. The lower tax rate of the self-employed allows them to retain a larger portion of their earnings. However, one of the major pitfalls of the household survey is its relatively smaller sample size. Also, labor market bulls attest that consumer spending will continue at its rapid pace, since the 94.4% of individuals who are working are prospering. The latest data from the Fed indicates that household net worth soared to a record high of $44.4trillion. Labor market bulls argue that the wealth of those employed will continue to fuel consumer spending and the economic recovery, giving corporations the confidence to increase hiring.
Outsourcing represents only a small portion of the jobs lost - it is NOT the problem
One of the media’s favorite scapegoat for job losses is outsourcing. It seems so much easier for the government to blame their lack of ability to create jobs on the attractiveness of cheap labor abroad. However, outsourced jobs represent a very small portion of the jobs lost. Forrester Research predicts that the U.S. will lose a total of 3.3 million service jobs to outsourcing between 2000 and 2015. This equates to approximately 220,000 jobs lost per year. This number pales in comparison to the 1.15 million workers who lost their jobs in 1999, which if you recall, was actually a relatively healthy year. The Senate has supported the media’s shift of blame by voting 70 to 26 to stop granting Federal contracts to companies that outsource offshore. Despite the manufacturing sector and government’s attempts to blame the loss of jobs on outsourcing, it is the NOT the problem. Outsourcing has been going on for centuries and represents only a very small portion of the jobs lost. Furthermore, the benefits of outsourcing outweigh the costs. If it weren’t for the economic downturn, US corporations would still be talking about how outsourcing has increased profitability. One of the biggest proponents of this belief is Fed Chairman Alan Greenspan. According to a McKinsey report, it is estimated that every $1 of costs that the United States moves offshore brings in a net benefit of $1.12 to $1.14. The low cost of producing abroad allows firms to increase their competitive advantages by reallocating its resources (money and people) to more productive tasks, which will ultimately be beneficial for the US economy.
What could tip the scales?
One of the most pressing threats to the labor market is an indirect one. In recent weeks, the market has been obsessed with the fact that the Bank of Japan may be shifting their currency policy - that is, significantly reducing or even halting currency intervention. This is a significant threat to the US economy because the Japanese government has traditionally recycled the dollars that they have purchased for intervention into US fixed income assets. The aggressiveness and persistence of their intervention has made them one of the largest holders of US Treasuries. Demand from Asian central banks such as the Bank of Japan has anchored yields, providing the US economy with some much-needed additional stimulus. If the BoJ truly shifts their currency policy and stops intervening or even decides to sell their treasury holdings, this could potentially send the bond markets tumbling, yields soaring and the dollar plummeting. The higher yields would raise borrowing costs, cramping the finances of corporations, forcing them to restrain spending and delay hiring - none of which would help to reverse the dollar’s decline or accelerate the economic recovery.
The leading argument for the BoJ‘s shift in currency policy is pressure from the US government. Aside from artificially inflating the value of the dollar, US pressure may also come from the government’s concern that foreign central bank intervention may be resulting in the development of an asset market bubble in the US debt market. With the Fed publicly announcing their intentions to artificially keep short rates low, many hedge funds, institutional investors, speculators and commercial banks have rushed into leveraged bond trades. In fact, a recent Merrill Lynch survey found that a record 73% of investors say that bond prices are overvalued. Therefore if the BoJ capitulates their bond holdings, this could pose a significant threat to the labor market, the US economic recovery and the US dollar.