Implications:  The job market boomed in February, a clear sign the Federal Reserve is behind the curve.  Nonfarm payrolls grew 313,000 in February, the largest increase in 19 months, beating the forecast from every economics group.  Meanwhile, civilian employment, an alternative measure of jobs that includes small-business start-ups, increased 785,000.  In the past year, nonfarm payrolls are up 190,000 per month while civilian employment is up 202,000 per month, both solid figures.  Given tax cuts and deregulation, we expect similar gains in the year ahead.  Although the unemployment rate remained at 4.1% in February, that stability was due to an 806,000 increase in the labor force.  As a result, the labor force participation rate rose to 63.0%.  That's still low by the standards of the past 40 years, but it ties the highest level since March 2014.  Some analysts will bemoan the tepid 0.1% gain in average hourly earnings in February, but these wages, which don't include irregular bonuses or commissions, are up a respectable 2.6% from a year ago.  Meanwhile, total hours worked rose 0.6% in February and are up 2.2% from a year ago.  As a result, total earnings, which combine the total number of hours and average hourly earnings, are up 4.8% from a year ago, suggesting plenty of growth in consumer purchasing power.  In other recent news on the labor market, new claims for jobless benefits increased 21,000 last week to s still-low 231,000.  Continuing claims fell 64,000 to 1.87 million.  These figures are consistent with continued healthy job growth in March, although at a pace that's likely to be slower than the rapid gains in February.  What will the Fed do with all this?  It's almost certainly going to raise rates on March 21.  At present the futures market in federal funds suggests 37% odds of the Fed raising rates by at least 100 basis points this year; we'd put those odds at more like 60%.  If so, long-term rates should continue to trend up as well.  

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Implications: When President Trump sees an increase in January's trade deficit he'll think the world is "killing" us in trade.  But what really matters, and what President Trump and other policymakers should be focused on, is that the balance of trade is due to voluntary decisions made by producers and consumers. Moreover, it is the total volume of trade – imports plus exports – that signals how much value consumers find in the global economy. The disappointing part in today's report was not that the trade deficit increased to $56.6 billion in January, but that total trade fell by $2.7 billion.  Exports fell $2.7 billion in January while imports were unchanged.  Some argue today's trade deficits must be offset by future trade surpluses.  We beg to differ.  The US finances trade deficits with foreign capital inflows. The trade deficit must equal foreign investment and foreign investors have been willing to be paid a very low return on their US investments.  So low, that Americans still earn more on their investments abroad than foreign investors earn on their US assets.  As long as that continues, and we see no reason why it shouldn't, the US can continue to run trade deficits.  Moreover, many of the policies President Trump has passed, including cutting tax rates and allowing for construction of more energy infrastructure, will make the US an even stronger magnet for capital from abroad.  The protectionist talk coming from Washington, along with the new tariffs on steel and aluminum, is worrisome. But as we wrote in our Monday Morning Outlook, the tariffs just announced only partially offset the benefits of the tax cuts already passed.  We will continue to watch trade policy as it develops, but don't see any reason yet to sound alarm bells. In other news today, nonfarm productivity was revised slightly higher from a preliminary reading of -0.1% at an annual rate to an unchanged reading in Q4.  Productivity is up 1.1% versus a year ago.  We expect productivity to accelerate in 2018.  Companies have increased business investment, which should generate more output per hour.  Meanwhile, the tight labor market should encourage firms to find more efficient ways to produce. In employment news this morning, the ADP Employment index showed private payrolls increased 235,000 in February.  As a result, we're projecting that Friday's official report on nonfarm payrolls will show a gain of 225,000.

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Source: St. Louis Federal Reserve FRED Database

Implications:  Service sector activity continued to hum along in February, though at a slightly slower pace than in January.  And while the pace of growth slowed modestly, the breadth of the expansion widened in February, with sixteen of eighteen industries reporting growth (two reported contraction), up from fifteen industries reporting growth in January.  Meanwhile, the most forward looking indices – new orders and business activity – both rose in February.  In fact, the new orders index reading of 64.8 represents the highest reading for the index going back to late 2005.  Paired with the recent tax reform, activity from the service sector looks set to remain robust over at least the coming months.  The supplier deliveries index was once again unchanged in February, but remains elevated from the levels that we saw in mid-2017, before the hurricane season. While there may still be some lingering remnants of storm impacts, this also reflects a pickup in orders and activity due to an accelerating economy.   The prices paid index declined to 61.0 in February but that still signals price increases, with rising prices cited across fuel types and metals.  In total, twenty-three commodities were reported up in price while just three were reported lower.  On the jobs front, the employment index declined to 55.0 from 61.6 in January. Our forecast may change with ADP and initial claims data due out before Friday's jobs report, but we are currently forecasting 222,000 nonfarm jobs added in February.  Recent tariff talk and poor trade policy decisions out of Washington are worrying, but the fundamentals for economic growth remain strong.  In other recent news, automakers reported selling cars and light trucks at a 17.1 million annual rate in February, down 0.5% from January and down 2.2% from a year ago.  Given the unusual strength of auto sales in the last few years, sales this year should continue to lag levels hit in 2016-17 as consumers shift their purchases toward other sectors.

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The US doesn't face "secular stagnation" caused by outside or uncontrollable forces, like foreigners (and bad trade deals), technology that steals jobs, or Unions that are too weak.  Growth is slow because government has grown too big.

In 2000, non-defense government spending was just 14.7% of GDP.  President Bush's "compassionate conservatism" - followed by TARP, which paved the way for President Obama to create the biggest new entitlement program since the 1960s - reversed that course, and non-defense spending is now 17.6% of GDP.  After the 2016 election, the pendulum started swinging in a different direction.  President Trump deregulated and passed the most far-reaching tax reform since the 1980s.

But spending has moved back in a Big Government direction, first with a "guns and butter" budget agreement, and now with the President's intention to impose across-the-board tariffs of 25% on steel imports and 10% on aluminum.     

Politicians and lobbyists had their phones vibrating off the table last week, with calls from industries trying to influence the direction of spending and market interference.  The swamp is filling up, not draining. 

We are fully aware that some countries either explicitly tax US imports or subsidize their own industries to gain advantage.  And we fully understand the US is probably the most free trade country in the world.  But that benefits US citizens.  If someone is willing to sell us something cheaper than we can make it, why not let them?

We should follow the lead of Ronald Reagan.  Back in November 1982, with the unemployment rate at 10.8%, he said, "We're in the same boat with our trading partners. If one partner shoots a hole in the boat, does it make sense for the other one to shoot another hole in the boat?  Some say, yes, and call that getting tough.  Well, I call it stupid.  We shouldn't be shooting holes; we should be working together to plug them up."

Moreover, the announcement last week provided no exceptions from the tariffs.  In other words, with regard to many of these countries, it's the US shooting the first hole in the boat!

Ultimately, tariffs are taxes.  They drive a wedge between willing producers and consumers, and do nothing to promote economic growth or jobs.  They also offset some of the benefits of the just-passed tax reform by lifting prices for goods that use steel and aluminum.

There are more workers in steel and aluminum "using" industries in the US than there are at steel and aluminum producers.  President Bush imposed the same kind of tariffs back in 2002, and then reversed course a year or so later.

What we find most confusing is that President Trump is listening to his Trade Czar Peter Navarro about the supposed benefits of tariffs, rather than just letting his tax cut and deregulation work by themselves.  If Reagan could be patient with free market policies when unemployment was 10.8%, Trump should be too when unemployment is 4.1% and headed lower.

The tariffs just announced do not fully offset, even remotely, the benefits of the tax cuts already passed.  But with the EU threatening tariffs on Harleys, Bourbon, and Levi's, it's possible a trade war begins.  Possible...not probable.

We're not giving up on faster growth.  Real GDP will likely grow 3%+ this year.  But the long-term outlook for faster growth is threatened by spending and tariffs.  Stay tuned.     

Brian S. Wesbury - Chief Economist
Robert Stein, CFA – Deputy Chief Economist 

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