Climbing a slow-growth wall of worry

The March jobs report was disappointing, but there is little reason to think that the first quarter weakness in the economy goes beyond the effects of bad weather, West coast port slowdowns, cutbacks in energy-related investments and statistical "noise." The economy most likely slowed down in the first quarter (the Atlanta Fed is now forecasting zero growth), but it is just as likely to resume moderate growth of 3% or so going forward. The market, however, continues to worry about slower growth, just as it has worried about other things in the past (e.g., Ukraine, Eurozone/China slowdowns, sharply lower oil prices). I suspect we will eventually overcome this new "wall of worry" just as we have overcome many others in recent years.

The March ISM report added fuel to the slowdown worries, coming in much lower than expected. But as the chart above suggests, the drop in the ISM manufacturing index is still consistent with decent underlying growth conditions of 2% or so.

As the chart above shows, swings in payroll growth such as we have seen in recent months do occasionally happen. We're likely to see a bounce back in the months to come.

As the chart above shows, the six-month annualized rate of growth in jobs hasn't changed much at all, and is likely to be around 2-2.5% for the foreseeable future. In order to see an acceleration from recent levels, we will need to see growth-friendly changes in fiscal policies (e.g., lower and flatter taxes on income and capital, reduced regulatory burdens).

Part-time employment is behaving exactly as it has during previous business cycles. There has been almost no growth in part-time employment since 2009, while it has fallen relative to total employment by a substantial degree. This is still the weakest recovery in modern times, but it is fairly typical in many other respects.

Real yields on 5-yr TIPS have fallen about 100 bps from their recent highs, which is a good sign that the market has repriced to much lower growth expectations (as low as 0-1%, as the chart above suggests) going forward. Weaker growth is priced in and pessimism has returned, at least for now. Barring a recession, this leaves the market vulnerable to upside surprises; arguably, this could take the form of simply avoiding another recession. The following all suggest that a recession is quite unlikely: the yield curve is still steep, real yields are very low, and swap spreads are firmly in "normal" territory.

The principle source of the recent rise in the Vix/10-yr index is the decline in 10-yr yields to 1.84%, which in turn has been driven by reduced expectations for economic growth. That has pushed back the timing of the Fed's first interest rate hike. If the economy continues on its current relatively weak path, the Fed is not likely to raise rates in May. Previous episodes of spikes in the Vix/10-yr ratio had more to do with nervousness in general (reflected in a rising Vix index).