January 15, 2015
· The labor market is recovering
· The consumer sector has an oil-price assisted tailwind
· The housing market has received nudges toward gaining momentum
The labor market is recovering
According to last week’s Bureau of Labor Statistics (BLS) employment report 252,000 jobs were created in December 2014, and the previous few months were revised substantially higher. The unemployment rate declined to 5.6%, though some of that can be attributed to a declining labor force (as opposed to new hires). With the assistance of the positive economic impact from lower oil prices, those numbers will be bolstered in the year to come.
The employment report was strong. US employment growth for all of 2014 was 2.95 million, the best year since 1999. We expect continued strong job growth in 2015.
But one weak spot was the 0.2% decline in average hourly earnings (the first decline since July 2013) which, for many, indicates that wage pressures remain low despite the steadily tightening labor market. We do not believe the decline is cause for concern. In fact, we suspect there is a distinct possibility of seeing reports of 3% wage growth this year, an improvement over the 2% wage gains that have been closer to the recent norm.
A separate survey released on Tuesday for the month of December, by the National Federation of Independent Business (NFIB) said that a net 17% of employers reported they planned to raise compensation in the months ahead, which is better than the 15% in November, and the highest since 2007. The NFIB has historically had a correlation to the Employment Cost Index (ECI), which is a quarterly economic report detailing the changes in the costs of labor for businesses in the US economy (i.e. wage growth). Although the ECI report tends to lag, we prefer it over the BLS’ employment report’s wage details because it is better correlated with consumer spending and thus important to use in assessing economic growth. Should correlations hold between the NFIB & ECI, year-over-year wage growth will increase.
However, we realize that there is a difference between what businesses say they will do and what they actually do. The NFIB survey also showed that the net percentage of businesses actually raising compensation increased from 21% to 25% in December, the third consecutive monthly gain and a new cyclical high. Additionally, according to the Job Openings and Labor Turnover Survey (JOLTS), the number of job openings rose 2.9% in November to 4.972 million. The number of job seekers per opening fell from 1.9 to 1.8 in November after starting the year at 2.7. That is below the 2.18 average that existed between 2002 and 2006. (Over that period, US wages rose an average of 2.8% per year, with an average unemployment rate of 5.4%.)Businesses are growing fast enough to need to hire, but with a shrinking pool of job seekers wages will likely be guided up.
A common reaction may be to have concern regarding the profitability of companies burdened with higher wage pressure. Without going into as many numbers as we just did, just remember that wage pressure is a symptom of economic growth (i.e. corporate revenue growth). Champagne problems, as they say.
The consumer sector has an oil-price assisted tailwind
Even without our expected 3% wage growth yet reaching into the economy, consumers are feeling better and spending on big ticket items. For example, vehicle sales ended the year on a strong note. The decline in energy prices may have helped vehicle sales (as a many folks are purporting), but we attribute most of the growth to improved access to credit as well as larger manufacturer incentives. If we are correct, that is good because it means the bulk of economic benefit from lower oil prices is yet to come. We believe that 2015’s economic growth will benefit more in the latter half of the year from cheaper oil.
Global oil prices are falling fast. It is very possible that measures of US inflation (of which oil is a component) will fall year-over-year by mid-2015. This is a deviation from previous expectations, and will have a broad impact. Lower inflation means higher real wage growth (real wage growth = nominal wage growth – inflation). Stronger growth in real wages will boost spending, but not immediately. Consumers tend to think of our income in nominal rather than real terms. It will take a few months for households to fully understand the impact of how lower inflation affects their real wages. By the time households realize this, they could very well also be getting nominal wage growth. This bodes very well for growth in the second half of 2015.
The impact of lower oil itself (in particular its impact on the cost of gasoline), as opposed to broader measures of inflation, should be large. And some of it should be felt more immediately than those broader measures. The Energy Department, in its latest Short-Term Energy Outlook, predicted that the average US household will save $750 in 2015 on lower gasoline prices, compared to 2014. That’s about $90 billion of consumer relief. Additionally, it is important to note that many gasoline purchasers use credit cards to buy gasoline. Lower gasoline prices mean not only availability of higher lines of revolving credit, but also lower debt service burdens that will contribute somewhat to an improvement in delinquency rates.
The housing market has received nudges toward gaining momentum
A negative in the economy is that housing demand remains weak, as evidenced by the last several weeks of mortgage purchase applications. The four-week moving average of mortgage purchase applications is down around six percent over the last month, and is down around six percent from its year-ago-level. Mortgage rates have fallen to their mid-2012 levels in recent weeks, but since many households refinanced or bought at those rock-bottom levels of 2012, all other things equal we may yet still need to see lower mortgage rates to see a substantial pickup in refinancing and mortgage applications.
However, we do see housing demand steadily building. Policymakers appear to recognize the importance of getting the housing recovery moving, and thus are focused on increasing the available mortgage credit and lowering mortgage rates. The Federal Housing Administration’s plan to cut insurance premiums by a half percentage point should provide incentive to first-time home buyers. Also notable is the decision by the Federal Housing Finance Agency to allow Fannie Mae & Freddie Mac to purchase certain loans with only 3% down payment, which should encourage lenders to extend more mortgage loans.
Of course, nothing helps the housing market more than rising prices. However, most recent data indicate that housing price growth has decelerated. The deceleration of house price appreciation is indicative of the still-weak pace of homebuyer demand. Nonetheless, all the preconditions for a stronger housing recovery are in place for the later-half of 2015 – labor market tightening, income growth picking up, capital gains realizations, and more available credit.
Bottom Line: The significant and rapid drop in oil prices has contributed to changing our original 2015 Economic Outlook for the better. Cheaper oil prices could act as a $90 billion boon to consumers that will bolster aggregate demand, as well as contribute to lower inflation and higher real wage growth.