Jim O'Sullivan: Economic Augur — The 2016 IA 25

The jobless claims report for the week ending April 30 showed a 17,000 increase in weekly claims to 274,000, but a four-week moving average of 258,000, just slightly above the a 42-year low reached two weeks earlier.  "The clear message is that the labor market remains pretty strong," said O'Sullivan.

O'Sullivan also looks for data to corroborate the economic numbers he's already analyzed, as well as "technicalities that can vary month to month." 

Then, using a "certain amount of judgment born of experience," O'Sullivan analyzes all this data as part of the work that he describes as "a little more art than science."  That, in turn, includes "judging current momentum, trying to figure out what's changing in terms of financial conditions, sentiment and policy […] and being open-ended as things change."

O'Sullivan has changed his outlook on the U.S. economy and Fed rate policy to keep up with changing developments. In January, he predicted the U.S. economy would grow between 2% and 2.5% this year, with core inflation rising to about 1.8% from 1.3%, unemployment falling to near 4.3% by year-end and the Fed Funds rate near 1.50%-1.75% following five rate hikes.

By April, he had downgraded his forecast with GDP growth closer to 2%, core PCE at 2.3%, year-end unemployment at 4.5% and Fed Funds at 1.25% — following three more rate hikes.

"Potential growth has slowed […] and is no better than 2% a year," said O'Sullivan. It's "clearly not what it used to be […], not what we've seen in past cycles." Indeed, the initial read on first quarter GDP growth was just 0.5%. 

Citing Economics Professor Robert Gordon, author of "The Rise and Fall of American Growth," O'Sullivan noted that U.S. economic growth is not likely to return to the levels that dominated in the 1950s or 1960s. The labor force is growing more slowly, in part because of retiring baby boomers, and productivity growth has also slowed, said O'Sullivan. But given that backdrop, he says the U.S. economy is doing pretty well and inflation is starting to pick up.

If that trend continues and unemployment falls further, the Fed will raise rates, so long as global financial markets are not in crisis, said O'Sullivan. The jobs report for April showed a lower-than-expected rise in payrolls of 160,000, but a 0.3% rise in hourly earnings and slight increase in weekly hours. 

"A bit weaker than expected," wrote O'Sullivan in his brief post-report analysis. "The pattern will naturally be read as evidence of slowing following the weakness in GDP in Q1, lessening the case for Fed tightening, although the lack of an uptrend in claims cautions against extrapolating yet." Spoken like an economist who continuously decodes the data.

— See the full 2016 IA 25 in the May issue of Investment Advisor, and find ongoing coverage of the honorees, including extended profiles, all month on the IA 25 homepage.