Market and economic update: August employment report left us on a more cautious footing

The strong U.S. equity market seems to affirm the U.S. economy remains healthy. Last week’s manufacturing data confirmed the market’s message, but to close the week, the August employment report left us on a more cautious footing.

  • The Institute for Supply Management (ISM) Manufacturing Purchasing Manager Index (PMI) survey rose 1.9 points to 59 for August, its highest level since 2011. Meanwhile, the non-manufacturing PMI index from ISM rose to its highest level since 2008, up 0.9 points from July to 59.6. Other positive news included vehicle sales, which reached their highest annualized rate in more than eight years, and factory orders, which jumped 10.5% in July.
  • A relatively benign jobs report left the market questioning how quickly the Federal Reserve (Fed) may raise short-term interest rates. Nonfarm payrolls rose by just 142,000 jobs in August, much less than the consensus expectation of 220,000, while the unemployment rate dropped 0.1% to 6.1%, helped by a 0.1% decline in labor force participation to 62.8%. Also leaving the market skeptical of Fed urgency to raise rates was a 0.1% decline in unit labor costs for the second quarter and a 0.7% decline in real (inflation-adjusted) hourly compensation. The Fed remains focused on the labor market as a gauge of economic health, and wage growth remains a particular concern. At this time, we believe the pace of economic improvement will lead to growing wage gains, which would allow the Fed to begin raising short-term interest rates as soon as March 2015 but more likely by the June 2015 meeting. Average hourly earnings have increased 2.5% year over year ending in August, according to the Employment Situation Report, consistent with our expectations for an improving labor condition.

Economic data reported outside the United States last week were weaker than conditions experienced domestically. Purchasing manager surveys in the eurozone, Japan, and China pointed to weaker expansions in manufacturing for August when compared to July. Sanctions against Russia, a key trade partner for Europe, have hampered the economic recovery, leading to zero growth in second-quarter gross domestic product (GDP) for the eurozone.



We believe the economy will continue to struggle in the face of deleveraging and the impact of sanctions, despite last week’s surprise lowering of policy rates by the European Central Bank (ECB). Growth in Japan has struggled in the face of rising tax rates to combat government deficits, with second-quarter GDP growth revised to an annualized decline of 7.1%. While growth may rebound in subsequent quarters, structural reforms have yet to be enacted and expanding monetary policy is unlikely to provide sufficient stimulus relative to the drag from tax increases. In China, the economy continues to struggle through rebalancing, with recent modest stimulus measures likely exhausted.

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