Farrell: Lower Oil—A Much Needed Welcome Tonic

I wrote yesterday that the jobs numbersmight start to look better by year-end since employment fell so much faster than production this past cycle. Soleil's chief economic advisor, former Fed Governor Lyle Gramley, put it better than I could in a conference call to the sales and trading group Monday afternoon. We are in essential agreement that such a development could occur (repeat, could).

The impression is that employment lags far behind an economic recovery but, except for the last downturn, the lag is usually a bit more than a month. It would not be historically aberrational for employment to turn up now, and, as Mark Twain said, if history doesn't repeat, it at least rhymes.

The second quarter productivity number was a very strong +6.5% and if Q3 GDP to be announced in a few days was to be as expected (around 3%) then productivity would be even stronger, maybe even 7% to 8%. The longer term productivity gain is more like 1.75% so these unusual numbers cannot be maintained as the work force is stretched beyond its limits. More bodies would be needed.

The four week moving average of initial unemployment claims has dropped about 20% the last six months. The number of temporary jobs lost to the bad economy has dwindled significantly. 200,000 temp jobs were lost in Q1, about 84,000 in Q2 and the third quarter number could well show a close to breakeven number. The work week has plummeted but seems to have bottomed and the manufacturing work week has even turned up slightly.

The "hire" rate, the number of new hires divided by total employment, has improved as well. What we need to see is continued GDP growth of 3% or so through the fourth quarter, a decline in the number of weekly initial unemployment claims to decisively below 500,000 (531,000 last week). October jobs data needs to show continued temporary job improvement, and the average work week needs to increase.

If it were to happen it would have a major impact on the markets in my opinion. If employment started to grow I think the bond market would react and yields would rise in response to the idea of a better economy. Coupled with the continued demand from Treasury for deficit financing, the ten year bond yield could well rise to above 4% (and that is my totally unscientific guess). Short rates would respond as well and rising rates in the US would play havoc with the dollar/oil, dollar/gold trade. I think the stock market would eventually like it as well since rates going up because of a better economy implies earnings could go up as well.

A lot of the predictions I have seen for higher oil prices in 2010 rest more on dollar weakness than an improving economy. Jacques Rosseau of Soleil/Back Bay Research noted last week that the consensus for oil as surveyed by First Call Research is about $70 in 2010. The forward futures curve, where trades actually take place, is predicting $81. I saw a report on the internet that Goldman Sachs sees a price as high as $110 in 2010.

Who's to say, but if interest rates went up, the attractiveness of using weak dollars to buy hard assets pales a bit. The President of OPEC said the other day the cartel would raise output if oil were to go to $100. OPEC is producing way above quota now (always hard to say how much but some estimates are they are 800,000 barrels a day over). Maybe it's time to consider the possibility that the price of oil could be frothy and that the weak dollar might not be weak forever, overproduction might catch up with demand realities, and what goes up can come down, at least a little. Lower oil prices would be a welcome tonic for the economy. _______________________________________