The job market continues to strengthen as output growth outpaces growth in labor productivity …
Above-trend growth in economic output (real Gross Domestic Product) continues to generate strong growth in payroll employment, despite strong growth in labor productivity (output per hour). Payroll employment rose by 248,000 in May, and the gains for March and April were revised upward.

The cumulative increase in payroll employment since the cyclical low last August now stands at 1.4 million jobs. The May level was still 1.3 million below the pre-recession peak in early 2001, but maintenance of strong job growth in coming months conceivably could eliminate that gap by the November elections.

‘Offshoring’ apparently is not a major quantitative issue, though human costs are sobering …
A new government report on “offshoring” of U.S. jobs provided another labor-market plus for the Bush Administration. On June 10, the U.S. Department of Labor made its first attempt to count the number of U.S. workers are fired when their jobs are transferred overseas. The results for the first quarter of this year suggest that offshoring is not nearly as pervasive a phenomenon as many analysts and politicians have suggested.

Furthermore, the results support judgments by both the President’s Council of Economic Advisers and Fed Chairman Alan Greenspan that offshoring is a natural part of an open and flexible world economy that should not be thwarted by “protectionist” measures. Both camps view education and job training as the appropriate ways to deal with the inevitable human costs of an open and competitive labor market.

The Labor Department report indicated that the number of jobs transferred overseas came to less than 2% of the private nonfarm workers who lost their jobs in the first quarter. Incidentally, nearly two-thirds of those jobs were transferred to an overseas location of the same firm rather than to another company abroad. Furthermore, the report said job relocations accounted for only about 7% of total job losses, and only two-fifths of total relocations were offshore relocations — rather than shifts to other locations within the U.S. [return to top]

Core inflation definitely has picked up this year, but recent readings have receded a bit …
The deflation threat of late-2003 has moved farther and farther behind us, and that’s really good news. On the other hand, we’re now faced with a problem typical of past economic expansions — a pickup of core inflation (excluding food and energy prices). Rising inflation eventually would take a real toll on the U.S. economy, and our central bank is committed to keeping the inflation process under close control. Both inflation and Fed actions to fight it entail upward pressure on the interest rate structure.

The core Consumer Price Index (CPI) is the most closely watched measure of core inflation, and this series accelerated markedly during the early months of the year — from a year-over-year pace of 1.1% in January to 1.8% in April. This pace of acceleration appeared ready to break through the 2% mark that various Fed spokespersons had suggested was an acceptable upper bound.

More recent indicators of core inflation have been less alarming. The core price index for personal consumption expenditures, a favorite of the Greenspan Fed, increased at a relatively benign 1.4% pace in April. And the core CPI slowed down a bit in May, increasing at a 1.7% rate (year-over-year). Even so, the year-to-date annual rate was 2.9% and the annual rate for the past three months was an outsized 3.3%. [return to top]

Bond markets are being whipsawed by shifting news on inflation …
Inflation is an unmitigated evil for the fixed-income markets, particularly for long-maturity bonds and mortgage-backed securities. The rapidly deteriorating inflation picture drove long-term rates up substantially from their recent lows in March, pushing the 10-year Treasury yield up by more than a percentage point to 4.85% by mid-June. The long-term home mortgage rate rose by nearly as much, reaching 6.35%.

The slight slowdown in the core CPI for May provoked a stunning bond market rally following the morning release of the data on June 15. Indeed, the 10-year Treasury yield was around 4.7% by the end of the day. The rally apparently was aided by market-friendly remarks by Alan Greenspan during his renomination hearing before the Senate Banking Committee the same day. [return to top]

Inflation situation is serious enough to kick off the Fed’s march back toward monetary neutrality …
The relatively benign core CPI for May sidelined market fears of a 50 basis point hike in the federal funds rate at the Federal Open Market Committee meeting on June 30, but a 25 basis point hike still is a virtual certainty. And although the Fed has continued to talk about a “measured” pace of increase beyond that point, Greenspan has made it quite clear that the Fed will do whatever it takes to keep the inflation situation under control.

NAHB’s forecast continues to assume that the federal funds rate target will rise from the current 1% to 1.75% by the end of 2004 and to 3.75% by the end of 2005. But everything is contingent on the course of the economy and the job market as well as on the path of core inflation.

Monetary neutrality entails a real (inflation-adjusted) funds rate of about 2%. The real rate currently is in the negative zone, and the nominal rate may need to move from 1% to 4% in rather short order. Fortunately, the bond markets already have largely anticipated such a move in short-term yields. NAHB’s forecast envisions another percentage-point increase in long-term rates as the Fed moves the funds rate up by 3 points (or more). [return to top]

The housing market continues to ride high in the midst of financial market turmoil …
Home sales and housing production have been remarkably high and stable despite volatility in both bond and stock markets, and house prices have shown ongoing strength as well. Housing starts for May totaled 1.97 units (annual rate) and single-family starts rose to 1.64 million. Furthermore, issuance of residential building permits climbed to 2.1 million in May, the highest in more than 30 years, and the single-family component hit an all-time high of 1.59 million.

NAHB’s Housing Market Index (based on surveys of single-family builders) edged down in June (from 69 to 67) but still threw off powerful positive signals regarding buyer demand and builder expectations. Weekly surveys of lenders regarding applications for mortgages to buy homes (MBA series) displayed considerable strength through the second week of June.

It appears that second-quarter home sales and housing starts may very well exceed the robust first-quarter numbers despite the rise in mortgage rates from their March lows. And it also seems highly likely that home sales and single-family starts for 2004 will exceed the record-breaking pace of last year. The multifamily sector figures to be about flat on a year-over year basis, with stable production of subsidized rental units and with a strong condo market offsetting some weakness in production of market-rate rental units. [return to top]

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