Friday is a big day for the US economy. We have labour market data in the form of non-farm payrolls, unemployment and average hourly earnings at 13:30 GMT, followed 90 minutes later by the ISM Manufacturing Index and the University of Michigan’s consumer confidence indicators. All of these are tier one data that have the potential to change the course of the rally we have enjoyed so far this year, for better or worse. Our view that the sell-off in Q4 2018, particularly in December, was an intra-cycle dip rather than the beginning of the end has held up, but Friday’s data dump will have a significant bearing on where we go from here.
The US consumer, which accounts for two thirds of the economy’s aggregate demand and as such is the most important component of US GDP, is currently in pretty good shape. This much was reiterated by Jerome Powell, Ben Bernanke and Janet Yellen more than once in their forum of Fed chairs past and present on January 4. Inflation is low at 1.9%, wage inflation is at its highest in nine years at 3.2%, and financial conditions remain decent, though we of course note that they tightened in December as a result of the generalised sell-off in financial markets.
We expect some moderation in the labour market data, after the extremely bullish report we had on the very same day as that all-important Fed forum. Non-farm payrolls are likely to be supportive, but we are certainly not anticipating a repeat of the 312k jobs added that we saw last month. Given inflation remains low, we believe an unchanged average hourly earnings growth number of around 3.2% would be the sweet spot for markets; healthy real growth in earnings, but not running away and causing second-order effects. This would allow the Fed to continue being patient with short term rates, a crucial ingredient in the powerful bounce back we have witnessed this year.
Consumer confidence has a lot to do with the availability of jobs and how much those jobs pay. However, in periods of market stress when equity markets fall, consumer confidence tends to follow with a lag. The preliminary University of Michigan consumer sentiment number for January (published January 18) showed a steep drop from 98.3 to 90.7. The final number will be out on Friday and the Bloomberg consensus is for a marginally better number than the preliminary release. Since the initial print the rally has cooled but we haven’t really seen a reversal, just a much slower pace with less volatility. Our gut feeling is that the number might actually be a little higher than consensus given the stabilisation we’ve seen in the second half of the month.
Last but certainly not least comes ISM Manufacturing. Although December’s absolute number of 54.1 was not particularly bad, there were two issues in the report that spooked markets. Firstly, the steep drop from a revised figure of 58.8 in November was the largest we have seen in years. Secondly, the detail was not encouraging. The new orders component, generally seen as a forward looking component of the index, came in at 51.1, the lowest since August 2016. Bloomberg consensus for the January absolute number is at 54.0, practically unchanged from December. If data such as the ISM Manufacturing fails to stabilise we think this would be taken quite negatively in markets for riskier assets. Part of the reason for the rally has been that valuations fell too far in December given the data was not really that bad. If this is no longer the case, then post-rally valuations might start to look expensive.
In our opinion, stabilisation in consumer confidence and manufacturing data is needed to justify the buoyant start to 2019. We agree with Powell, Bernanke and Yellen: the US economy is decelerating but is still in decent shape, led by the consumer. Markets need Friday’s data to back up this view.