Atlanta Fed Forecasts 5.4% GDP Growth vs. 3% by NY Fed

02/05/2018 12:20 pm EST

Focus: MARKETS

Don Kaufman

Co-Founder, TheoTrade

If we assume the Employment Cost Index is right, we are nearing the end of the labor market cycle. If we assume the Atlanta Fed report is right, then the labor market has already peaked. A recession could be coming next year, writes Don Kaufman, co-founder of TheoTrade.

Great ADP Report

The January ADP report showed there were 234,000 new private sector jobs added in January. At this point in the cycle, this is a great report. Because of the tightening slack in the labor market, there aren’t many people available to take new jobs. The jobs growth, according to the BLS report Friday, has been on a steady downtrend because of this.

That’s a normal late cycle indicator. Every report that shows above 200,000 jobs created supports the notion that the economic cycle has a few more quarters left. This ADP report was the 6th best report out of the last 12.

Mid-sized businesses led the charge for the 3rd straight month adding 91,000 jobs. Small businesses added 58,000 jobs and large businesses added 85,000 jobs. The services sector added most of the jobs as it came in at 212,000; the goods producing sector came in at 22,000. Manufacturing added 12,000 jobs.

It’s interesting to see that natural resources and mining only added 1,000 jobs because commodities have been rallying lately. Copper has been doing really well in the past 3 months. From early December to late December, it increased from about $2.94 to $3.30. Since then, it’s down about 10 cents. As you can see from the chart below, the net speculative position in CME copper futures looks just like WTI; the speculation is making new all-time highs. The latest trade has been to buy oil, copper, and stocks while selling the dollar and treasuries.  

chart 1

The trade, transport, and utilities segment of the services sector added the most jobs as it was up 51,000 in January. This is consistent with the Cass Freight Index which measures rail shipments. As you can see from the chart below, the November and December shipments were better than all the previous 5 years. Once again technology hemorrhaged jobs as it lost 3,000. The professional and business industry added 46,000 jobs and the education and healthcare industry added 47,000 jobs.

chart 2

Manufacturing ISM report was great

One of the biggest stories on Thursday was that the Atlanta Fed GDP Now forecast was updated to show it expects 5.4% growth in Q1. That’s much higher than the New York Fed Nowcast which expects 3.09% growth.

The Atlanta Fed’s report sounds ridiculous because it’s so much higher than the current trend and we don’t have much data from Q1 to digest yet. If I had almost nothing to go by, I would guess GDP growth would be 3%.

The recent 1.2% leap in growth expectations in the GDP Now report partially came from the increase in expected real consumer spending growth from 3.1% to 4.0% which was catalyzed by the strong ISM Manufacturing report. It seems odd to look at a manufacturing report when coming up with a guess for how strong consumer spending will be.

This oddity is why the Atlanta Fed’s GDP Now is almost always wildly off to start the quarter. The forecast for real private fixed investment growth increased from 5.2% to 9.2%. That’s probably going to be revised down because it’s ridiculously high. The increase was caused by the ISM Manufacturing Report and the construction spending report.

Obviously, you can tell the ISM Manufacturing report was strong based on its effect on the GDP Now estimate. It’s interesting to see such strength because the Empire State, Philly Fed, and Richmond Fed manufacturing reports all showed weakness. It’s possible they were all wrong.

The Markit report showed services were weak and manufacturing was strong. The ISM PMI was 59.1% which was down 0.2% from December, but 1.4% higher than the 12 month average. As you can see from the table below, the report had a mixture of indexes decelerating and accelerating.

The all-important New Orders index was down 2 points to 65.4 from 67.4.

chart 2

Consistent with the other reports, the price paid index was up. It accelerated up 4.4 points to 72.7. This supports the 10 year breakeven inflation rate which has been in a strong uptrend recently. The latest reading is 2.11%. Every single commodity the report checked was up in price and many were in short supply.

Since the GDP Now estimate was so strongly affected by the PMI, let’s look at what it implies. The January report is consistent with 4.9% GDP growth. The Atlanta Fed even outdid the ISM’s optimism. Since I’m not even sure manufacturing was strong in January, it’s way too early to start expecting GDP growth to be above 4%.
Let’s look at some of the quotes from the report. A machinery company said, "We have heard reports of additional business due to the recent reduction of tax rates." That’s great news. The tax cut is one of the reasons why I expect near 3% GDP growth in 2018.

A furniture and related products company said, "Our usual winter slowdown has not occurred, and we are very busy with new orders." This is consistent with my thesis that furniture will do well because of the tax cut.

A plastics and rubber products firm said, “Business is starting the new year strong. Consumer confidence seems to be driving a lot of our customers’ order requirements higher." It’s interesting to see strong consumer confidence translating into strong sales. This is consistent with my thesis that metrics that measure results will come in line with sentiment metrics.

Wage growth

As you can see from the chart below, the December Employment Cost Index has been rising while the Atlanta Fed wage growth metric has been falling. I tend to agree with the ECI because the labor market is very tight according to all the metrics I follow.

The jobless claims report showed 230,000 claims and the week prior was revised down 2,000 to 231,000. The Q4 ECI showed 0.6% growth quarter over quarter and 2.6% growth year over year. Technically, both reports are showing about the same results, but the dramatic difference in the trends in the past 12 months is noteworthy.

The ECI is consistent with rising inflation and a late cycle jobs market. If we assume the ECI is correct, we are nearing the end of the labor market cycle. If we assume the Atlanta Fed report is right, then the labor market has already peaked and a recession could be coming next year.

chart 4

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