Brian Nick, Chief Investment Strategist, TIAA Investments
September 1, 2017
“Rise up.” – Bruce Springsteen, from “My City of Ruins”
With rain still falling in Texas and the Gulf, it’s hard to dive too deeply into the storm’s implications for the outlook for the region and the broader economy. Clearly, the population displacement in the Houston area will have a non-trivial effect on third-quarter GDP, while the subsequent rebuilding effort will be additive to growth in future quarters, similar to the efforts after Hurricane Katrina in 2005 and the Asian tsunami in 2011.
One thing we know for sure is motorists are already paying more at the pump. Over the past week, gasoline prices rose, on average, from $2.35 to $2.52 per gallon nationwide (according to AAA), as several large Gulf Coast refineries closed within days of the storm making landfall. This has led to a roughly 30% drop in the country’s capacity to convert crude into gasoline, diesel, and other fuels. Additionally, refineries still in operation have struggled to import crude because of outages at port facilities.
Brian Nick, Chief Investment Strategist, TIAA Investments
A prolonged increase in gasoline prices acts as a tax on consumers, whose savings rates are already lower than they were the last time gas prices were this high. If prices increase further and stay elevated—which is far from a certainty—real household spending would probably fall in the second half of the year to compensate. While gasoline prices spiked, oil prices declined during the week amid a drop in demand from refineries.
Houston faces enormous challenges in addition to restarting its refineries and reopening its ports. According to White House reports, more than 300,000 people have registered for disaster assistance, and about 100,000 homes—many of which were not fully insured—have been affected by the storm.
Nonetheless, we expect the city’s economy, which accounts for about 3% of U.S. GDP, to fully recover. Urban areas hit by major storms tend to experience immediate, short-term economic dips caused by lower consumer spending, followed by more expansive, investment-driven “recovery bumps.” In Houston’s case, this turnaround could begin as soon as next quarter and last throughout 2018, supported by its large and growing population, diversified economy, and role in global trade.
The U.S. labor market generated 165,000 jobs in August, below forecasts but in line with the economy’s 12-month average of 174,000. June and July payrolls were revised downward by a combined 41,000. Additionally, the unemployment rate ticked up to 4.4% from July’s 16-year low of 4.3%, while the labor force participation rate was unchanged at 62.9%. Wages grew just 0.1% in August and 2.5% over the past 12 months.
Preceding this moderately disappointing report was a mid-week release of the Federal Reserve’s preferred inflation barometer, the PCE price index. Based on this measure, both headline and core inflation (which excludes food and energy prices) edged up just 0.1% in July and 1.4% year over year.
Against this sluggish inflation backdrop, the market-implied probability of a December rate hike remained at 33% as of September 1. (We think the odds are more like 65%.) But it’s still pretty early in the ballgame. Between now and then, the Fed will be able to digest three more sets of monthly payroll reports and PCE readings, so the perceived likelihood of a rate increase could change dramatically. In our view, there’s no urgent need for the Fed to abruptly tighten monetary policy given the lack of inflationary pressures.
U.S. equity markets had a lot on their mind besides the jobs report, including Hurricane Harvey, more North Korean missile jitters, and a bevy of economic data. There was no stopping the S&P 500 Index, however, which rose 1.2% for the week through August 31 and was up again to start September. U.S. equity valuations remain at high levels based on a “Goldilocks” scenario of modest inflation and solid economic growth. Europe’s STOXX 600 Index also advanced (+0.31% in U.S. dollar terms) for the week.
In U.S. fixed-income markets, the yield on the bellwether 10-year note was trading at around 2.15% on September 1, slightly below where it began the week. The yield is now down about 30 basis points (0.30%) since the beginning of the year.
In addition to July’s jobs report, the unofficial end of summer brought with it a broad range of key U.S. data releases. Among the week’s reports:
Meanwhile, Eurozone economic data releases for August were mostly positive:
With the U.S. economy continuing to add jobs at a brisk pace and employers clamoring for qualified workers, we’d expect to see wages rise meaningfully. But today’s release of August employment data contained yet another disappointment on the wage growth front, with only tepid improvement on both a monthly and year-over-year basis.
Some economists believe this ongoing trend is the result of slack remaining in the labor market. On the other hand, with job openings at an all-time high and the unemployment rate down to 4.4%, it appears that new labor supply is becoming scarce.
That’s why we think the lack of wage growth is due more to structural shifts than to cyclical weakness. Both new entrants into the job market (who tend to be younger) and new full-time workers (many of whom previously worked part-time) have been accepting lower wages. Meanwhile, the pace of retirements has picked up to a historically high rate. Presumably, many of these retirees are Baby Boomers who were highly compensated late in their careers. Overall, the current entry-exit dynamic in the labor force has brought down the average level of wages and wage growth.
If we’re right, this longer-term, generational transition could lead to lower top-line wage growth for some time.
© 2017 Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA), 730 Third Avenue, New York, NY 10017