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US payrolls indicate an easing US economy

Srinivasa Sundararajan

THE Federal Reserve Board Chairman, Mr. Alan Greenspan, seems to have achieved the impossible. Within a few weeks of the Fed giving the market what it was expecting, the global economic powerhouse (the US economy) has sent enough signals that it is slowi ng down.

The market was so used to doses of strong data from the world's strongest economy, it forecast that the FOMC would tighten the screw on monetary policy quite aggressively last time.

With the market expecting a 50 basis points rate hike, the logic seemed to be: give the market what it wanted. The Fed Chairman responded promptly by matching market expectations.

He did not stop there. The FOMC minutes clearly underscored that the Fed had not finished hiking rates. The policy statement underlined that the committee members were increasingly concerned about demand-supply imbalances heightening inflationary pressur es in the US economy.

Having justified the 0.5 per cent rate hike, the statement went a step further and prepared the market for additional rate hikes. The Chairman cautioned that the Fed was worried that demand-led inflation risks could increase in the foreseeable future.

Most of the analysts and economists were convinced that the Fed would hike interest rates again, between 0.75 per cent and 1 per cent. The data releases were so convincing that asset prices priced-in additional rate hikes in June and so on.

The asset markets got the first dose of sweet music as retail sales data showed signs of a slowdown. While one cannot conclude that the economy is slowing on just one piece of data, the financial markets carefully perused successive data releases.

The first indication of the aggressive rate hikes having impacted the US manufacturing data came in the form of the NAPM data. The headline index was weaker than expected at 53.2 in May after April's 54.9, while new orders, production, and prices-paid by manufacturers showed slackness in the manufacturing sector.

The prices-paid component softened by 10 points to 65.8 compared to April's 76.0. Easiness was also noticed in construction activity, which declined by 0.6 per cent for the first time in seven months. Although consumer confidence soared to 144.4 in May, which is nearly 9 points above Wall Street's expectations, durable goods orders declined by 6.4 per cent in April. Most of the fall can be explained to the fall in electronic and other electrical equipments.

Despite the softness in the durable goods sector, a detailed analysis of non-defense capital goods data suggests that this sector would probably grow on a strong note.

While all these data cheered the asset markets, which rallied for the greater part of the week, the factory orders declined sharply by 4.3 per cent as against a strong 2.7 per cent gain in March. Despite this, capital goods orders (ex-aircraft) were revi sed to 2.3 per cent as against the preliminary 1.1 per cent.

This once again shows that although the economy seems to be slowing across the board, the capital goods sector still looks placed on a strong wicket. Since the lead-lag between the rate hike and its impact on this sector is considerable, it may be a whil e before this sector's strong growth eases a bit.

The highlight of last week's economic data were the non-farm payrolls which were exceptionally soft and well below the market expectations. The market had forecast the creation of 366,000 new jobs in May. The economy produced just 231,000 jobs in May. If one were to remove the impact of Census workers, 126,000 jobs were lost in May alone.

The rate cut seems to have produced the desired result. Job losses were registered across all sectors of the economy, with the notable exception of services.

Overall, the economy has indeed shown signs of a soft landing, which means that the Fed would certainly not tighten in June and, perhaps, not even in the next couple of meetings. If future data releases confirm this expectation, one can conclude that US rates may have already peaked.

The US asset markets have made a positive note of this. If the softness shows signs of a hard landing, it would be time to look for rate cuts again!

(The author is a Treasury Executive in a leading foreign bank. Responses can be mailed at drsrinisundar@yahoo.com)