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Economy Adds 92,000 Jobs in July

Prof. Peter Morici - 8/5/2007

Friday, the Labor Department reported the economy added 92,000 payroll jobs in July, down from 126,000 in June. The consensus forecast was 135,000.

The jobs report indicates the economy continues to expand but growth is much more moderate than the 3.4 percent recorded the second quarter. Inflation from higher oil prices remains a threat, and the Federal Reserve will not alter its policy posture barring some unforeseeable event, such as revelations of widespread fraud in financial markets, a natural disaster or disruptions of Middle East oil supplies.

The household survey of employment, which includes the self employed, shows the unemployment rate at 4.6 percent in July, up from 4.6 percent in June. This unemployment rate is hardly low by historical standards. In November 2000, when George W. Bush won the presidency, unemployment was 3.9 percent when the percentage of adults in the labor force was much higher than it is today.

The household survey indicates another 86,000 adults left the labor force, as the ranks of discouraged workers continue to swell. Were the same percentage of adults participating in the workforce today as in 2000, the unemployment rate would be about to 6.3 percent.

Wages increased a moderate 0.6 cents per hour, or 0.3 percent, despite surging energy and food prices. Moderate wage and labor productivity growth should help keep core inflation in check, but rising oil prices and pressure from the ethanol program on grain and food prices could yet ignite a wage-price spiral. The Federal Reserve will remain cautious about inflation. Look for no change in Federal Reserve target interest rate until at least December.

Outlook for Economic Growth

In the second quarter, the economy added 436,00 new payroll jobs, or about 145,000 per month, and the economy expanded about 3.4 percent, thanks to a large jump in government spending, continued strength in nonresidential construction and business investment, and improvements in the real trade deficit.

The July jobs figure indicates the economy continues to expand but more moderate growth, in the range of 2.3 to 2.8 percent, is likely for the second half of 2008.

In the third and fourth quarters, the large second quarter jump in government purchases of goods and services should not repeat. Nonresidential construction is likely to grow moderately, and spending on equipment and software spending will continue to expand; however, business investment will not expand rapidly enough to compensate for slower growth in government spending and a less positive report from the foreign trade sector.

The second quarter trade deficit improved thanks to a weaker dollar against the euro, pound and Canadian dollar that boosted exports. The U.S. dollar remains overvalued against the yen and Chinese yuan, and the trade deficit with China continues to surge. Without a significant realignment of the dollar against the yuan and other Asia currencies, the real U.S. trade deficit is not likely to improve much more in the second half of 2008.

Essentially, new jobs are being created in sectors of the economy that do not export or compete with imports, and generally, labor productivity is about 50 percent lower in sectors that do not compete in international commerce. Indicative of the problem, manufacturing, where productivity and wages are among the highest, shed 2,000 jobs in July and 45,000 in the second quarter. During the Bush years, manufacturing has shed more than two million jobs, and the trade deficit has been responsible for about half of those.

Stronger Growth and Rising Stock Prices Ahead

Growth should be moderate in the second half and average interest rates should, generally, should remain steady.

Higher global oil prices threatens another bout with inflation but the Federal Reserve can do little to dampen these pressures by raising short-term U.S. interest rates. With moderate growth ahead, look for the Federal Reserve to stand on the sidelines until the end of the year. The target Federal Funds rate should remain at 5.25 percent at least until the December meeting of the Open Market Committee.

Short term Treasury obligations are currently overbought. Treasury yields will rise, and credit for private equity finance and merger activity will reemerge. Mortgage financing will remains available for creditworthy borrowers with stable, verifiable incomes. Recent surges in rates on those mortgages will moderate.

After some reorganization within the mortgage banking industry and moderation in expectations in the secondary mortgage and bond markets, less creditworthy borrowers will find financing; however, risks will be better assessed and more fairly priced into higher risk mortgages, and investors will be better rewarded for accepting those risks.

Losses will be sustained among investors that purchased collateralized debt obligations and among banks assisting subprime lenders work out their mortgages over a period of several years. However, not on the horizon is a repeat of the savings and loan crisis, or a debacle in corporate balance sheets that followed the revaluations in the wake of Enron’s collapse. The fundamentals under the credit market are firm, despite fears to the contrary.

Stock prices will regain their footing and outperform the U.S. economy. Most large U.S. companies earn a good deal of their profits abroad. The combination of strong growth in Asia, coupled with moderate growth in the United States, is good for their bottom line.

Weaker borrowers will have to pay more and strong borrowers less. All of that is healthy and bears the mark of markets regulating behavior--scolding the imprudent and comforting the wise.

A weaker dollar makes U.S. equities a particular bargain for foreign investors, especially in Europe and Japan. Large U.S. multinationals earning significant shares of their profits in Asia are a great play for European and Japanese investors who sit on strong euros and pounds but have few good investment options at home.

Surging corporate profits, moderate growth and steady interest rates at home, and more robust foreign demand for U.S. equities should power up U.S. stock prices.