Morgan Stanley: "Wage Growth Is Leveling Off, May Be Slowing"

While Friday"s headline payrolls print - the lowest since May - was disappointing even to the biggest economic optimists, many found refuge in the sharp drop in the unemployment rate, which ticked lower to 4.5%, the lowest print in a decade. And yet there was a problem: with the unemployment rate tumbling, at least in theory indicating even less slack in the labor market, wage growth barely hit consensus estimates. Instead, if indeed the growth narrative is accurate, and if more people were employed, wages should be rising. However, it was this weakest link of the entire reflation/recovery narrative that disappointed once again.

In fact, it was even worse: as Morgan Stanley"s Robert Rosener write overnight, "wage pressures in March were supported almost entirely by a massive jump in earnings in Professional & Business Services. Outside of this bright spot, wages in other industries were muted, and suggests wage growth in a broad range of industries may be leveling off, or even slowing."

As Rossener further notes, to describe wage pressures in March as "spotty" may be an understatement. The 0.19%M gain in average hourly earnings was supported almost entirely by a massive jump in the Professional & Business Services industry. Outside of this one bright spot, wage pressures in other industries were surprisingly muted (Exhibit 1), and suggests wage growth in a broad range of industries may be leveling off or even slowing.

According to MS, the 0.92% sequential gain in average hourly earnings in Professional & Business Services was the second largest monthly increase on record, and this accounted for nearly all of the increase in aggregate average hourly earnings. In other words, average hourly earnings would have been roughly flat on the month were it not for the outsized increase in earnings for Professional & Business Services. To be sure, the bounce in wage growth for this job category was decidedly welcome: As a generally high-paying industry, stronger wage growth in Professional & Business Services can go a long way in supporting stronger aggregate outcomes for average hourly earnings.

The key question from here is whether or not the upside in March can be sustained, or if it"s just noise.

Yet while the silver lining in professional services will be closely watched, a bigger question is what happens to wages in all the other key indudtries, where as noted above, March saw substantial weakness.

Here, Rosener writes that "consistent with signs of a recent softening in wage pressures in a number of industries, our wage growth diffusion index has shown a meaningful narrowing in the breadth of wage pressures across industries in recent months—only 38.5% of industries are now showing above-trend rates of wage growth, down from 46.2% in February and a high of 61.5% in August 2016."

Some more observations from Morgan Stanley:

• The jump in average hourly earnings in Professional & Business Services helped boost wage growth in the broader high-wage industry segment as a result, with average hourly earnings in high-wage industries rising to 3.0%Y in March from 2.7%Y in February (Exhibit 5).


• Wage growth in middle-wage industries fell sharply in March to 2.1%Y vs 2.6%Y in February (Exhibit 6).


• Wage growth in low-wage industries ticked down to 2.6%Y from 2.8%Y, although smoothing through the volatility shows a steady trend for wage growth in low-wage industries around 2.6%Y (Exhibit 7).


• Consistent with fewer workers experiencing wage gains, the median rate of wage growth across industries fell notably in March. Median wage growth fell to 2.5%Y in March from 2.8% (Exhibit 8)

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Taking all that, and the bigger jobs picture in mind, what does the labor market mean for the Fed"s June decision? The answer: it depends on whether you see the glass as half empty or half full.

The optimist says, "Well, the unemployment rate continues to fall and the Fed has been expecting the pace of job gains to slow. At 163k per month over the past 6 months, shown in Exhibit 2, the economy has been adding jobs well above the pace needed to keep the unemployment rate moving lower." The labor market is tightening, right?

The pessimist says, "Despite continued strength in the labor market, signs of labor market tightness are few and far between. Yes, the unemployment rate is falling, but core measures of wage growth remain anemic. Just look at the year-on-year rate of wage growth among production and non-supervisory workers, as shown in Exhibit 3. At 2.3% Y/Y in March, growth in wages of these workers was lower than it was in the year ending early 2014. This just means NAIRU (Natural Rate of Unemployment) is lower."

Morgan Stanely"s summary:

"Even though NAIRU could be (much) lower, we don"t think the FOMC consensus will let that affect their decision on rates for now. One weak headline payroll number is also unlikely to dissuade the consensus from believing that continued gradual rate hikes remain appropriate. However, if the April or May payroll number disappoints, that could change.... we"ll be watching carefully for clues as to whether small business hiring slows in the wake of inaction by the Trump administration and Republican-controlled Congress. So we"ll be watching with interest the NFIB Small Business Optimism index released on Tuesday, April 11."

What this means for markets and the economy: the Trump "reflation" rally, having already withered across many market indicators, has finally moved to the economy and actual wages, where it increasingly appears to have been nothing more than a mirage.

Is A Fed Rate Hike Good Or Bad For Treasuries?

Well, it’s probably a stretch to say the next installment in the Fed’s tightening cycle is finally here. After all, as Bloomberg"s Richard Breslow, a former FX trader and fund manager, notes, it was only a couple of weeks ago that this foregone conclusion wasn’t even on the market’s radar.

The abrupt about-face was jarring and out of character in its timing, but I like the lack of overbearing hand-holding.

It’s about time that forward guidance doesn’t have to mean as far as the eye can see. Is the Fed behind the curve? Are they letting the economy run hot? Not to any dangerous extent. But that doesn’t mean it’s not time to start getting on with things and make some faster progress toward the still very-low levels that might approximate the neutral rate.

Unfortunately, the market will still be fixated on the notion of whether it’ll be a dovish or a hawkish hike. We’ll get a hike, most likely more upbeat projections and assurances that if things keep evolving as they have and according to forecast there will be opportunities to do more. The Fed’s thinking three would be nice this year. The market is pricing less than that. Guess what? They’re unlikely to say they were only kidding.

But you’re not going to get some blanket pre-commitment, data-dependency didn’t die. You’ll also hear from a committee that’s a lot less afraid of making a mistake. If that’s not good enough for you, than your spirit may be permanently impaired.

Is the economy firing on all cylinders? No. But it’s doing well enough to justify and handle rates that don’t imply crisis. Yesterday’s release of NFIB Small Business Optimism showed it’s holding at levels not seen since 2005. It doesn’t get a ton of attention but it’s soft data that can translate into hard wage and, yes, productivity increases.

Active traders are short bonds. I’m warned, therefore, to be careful of some massive rally. I’m skeptical. A market of this size will require a change of perceptions to be bullied for more than a very short amount of time by some short- covering. If people begin to think 10-year Treasuries are going north of 3%, do you really think there aren’t enough longs to fill in the bids?

Crowded trades may indeed have structural buffers built in, may even have short-term corrections from panics, but there’s no immutable law that says they can’t work if they’re right.

Interstingly, Bloomberg"s Wes Goodman suggests the opposite might happen with a Fed rate-hike actually sending Treasury yields lower...

The last two Fed hikes marked a peak in Treasury yields, and the same thing will probably happen now, said Toshifumi Sugimoto at Capital Asset Management in Tokyo. Higher borrowing costs keep inflation in check and support demand for U.S. government debt, he said.

Two-year break-even rates and oil prices are plunging, underscoring concern the Fed has yet to end the risk of disinflation.

Benchmark 10-year yields have failed to hold above 2.6 percent, the level bond market guru Bill Gross said will signal the start of a bear market if sustained on a weekly basis. Instead of breaking to higher levels, rising yields are drawing demand.

Treasuries offer a growing premium over their peers. U.S. two-year notes yielded as much as 223 basis points over like-maturity German securities earlier this month, the biggest spread since 2000 and another reason to favor U.S. debt.

There will be many different issues to focus on from this meeting -- the dot plot, the phrasing around the balance of risks, and any mention of balance sheet management -- so the short-term reaction may be volatile. Don’t be scared off by any initial yield spike.

Either way, we will see very soon.

What's Wrong With This Picture?

Turn on any mainstream business channel (or President Trump"s tweet stream) and you will be told how "awesome" everything is going to be... look at stocks, look at sentiment surveys, look at consumer confidence, look at small business optimism.

There is two small problems with all of this...

1) The "hard" data is not confirming the "soft" data at all...

Philly Fed beating by 10 standard deviations, NFIB small business optimism at record highs, but Industrial Production is dropping, real wages are shrinking, and the housing market is imploding.

And 2) Earnings Expectations are declining...

Do the analysts not pay attention to how awesome everything will be? Are the CEOs not adjusting expectations higher because of how great America is going to be again?

It appears not.

As Factset notes, the S&P 500 forward P/E is at its highest since 2004...

During the past week (on February 15), the value of the S&P 500 closed at yet another all-time high at 2349.25. As of today, the forward 12-month P/E ratio for the S&P 500 stands at 17.6, based on yesterday’s closing price (2347.22) and forward 12-month EPS estimate ($133.49). Given the high values driving the “P” in the P/E ratio, how does this 17.6 P/E ratio compare to historical averages? What is driving the increase in the P/E ratio?

The current forward 12-month P/E ratio of 17.6 is now above the four most recent historical averages: 5-year (15.2), 10-year (14.4), 15-year (15.2), and 20-year (17.2).

In fact, this week marked the first time the forward 12-month P/E has been equal to (or above) 17.6 since June 23, 2004. On that date, the closing price of the S&P 500 was 1144.06 and the forward 12-month EPS estimate was $65.14.

Back on December 31, the forward 12-month P/E ratio was 16.9. Since this date, the price of the S&P 500 has increased by 4.8% (to 2349.45 from 2238.83), while the forward 12-month EPS estimate has increased by only 0.5% (to $133.49 from $132.84).

Thus, the increase in the “P” has been the main driver of the increase in the P/E ratio to 17.6 today from 16.9 at the start of the first quarter.

It is interesting to note that analysts are projecting record-level EPS for the S&P 500 for Q2 2017 through Q4 2017. If not, the forward 12-month P/E ratio would be even higher than 17.6.

Even Factset sounds skeptical.