Today, in addition to reporting a stronger than expected 258,000 increase
in May non-farm payrolls, the Labor department also upwardly revised March
and April gains to 353,000 and 346,000 respectively. While superficially
May’s numbers appear strong, they nevertheless represent a significant decline
from the pace of the prior two months, and the second month of consecutive
declining payroll growth. The dollar’s sharp decline following this seemingly
positive release, (with the U.S. dollar index falling over 4% in the last
two weeks, to its lowest weekly close in three months) suggests that the
best days of job growth are indeed behind us, and that the prior months of
strong gains were nothing more than a counter-trend rally it what is otherwise
a bear market in U.S. job creation.

A closer look at May’s job report reveals that the majority of the gains
once again occurred in areas closely associated with real estate and mortgage
refinancing, and are therefore unsustainable in the higher interest rate
environment into which the U.S. economy is about to enter. Of the 258,000
jobs created 32,000 were in construction, 15,000 were in financial services,
and 142,000 were in retail sales. Even the 32,000 jobs gained in manufacturing
were attributable mainly to construction-related industries, such as fabricated
metals, wood products, etc. Basically May’s employment gains resulted from
building houses remolding houses, remolding houses, selling houses, financing
the purchasing of houses, refinancing existing mortgages on houses, and the
selling of products
to homeowners spending
the money borrowed against houses. In other words, as goes the housing market,
so goes the economy and the job market.

Even though long-term mortgage rates have risen to two year highs, most
homebuyers have responded to higher rates not by curtailing their borrowing
but by changing the terms of their borrowing. The recent surge in the use
of adjustable rate mortgages (ARMs) has provided homeowners and homebuyers
a temporary reprieve from higher interest rates, but for how long, and at
what cost? That fact that so many have taken on so much adjustable rate debt
means that the U.S. economy and therefore the U.S. job market are now more
interest rate sensitive than at any time in history.

When short-term rates finally rise, so too will ARM payments, leading directly
to reduced discretionary consumer spending, as income previously available
for such expenditures is diverted to meeting higher ARM payments. Further,
by directly increasing the cost of home ownership, the price of houses will
fall, removing the biggest economic and employment prop of all, home equity,
and the consumer spending financed by its continuous extraction. The resulting
collapse in consumer spending will lead to significant job losses throughout
the economy. Higher unemployment occurring concurrent with rising interest
rates, higher inflation, and falling real estate prices will only make a
bad situation worse. Wide spread real estate foreclosures will exacerbate
the fall in home prices, further reducing consumer spending, and accelerating
the pace of job losses. In addition, given the short maturities of the Federal
debt, and the cyclicality of the Federal budget, a recession concurrent with
rising interest rates will significantly expand an already enormous Federal
budget deficit. This will put the Federal government in the precarious position
of having to cut spending or raise taxes during what is likely to have already
become a severe recession.

With the dollar’s down trend resuming, oil prices soaring, and inflation
rising, the Fed can not afford to remain “patient” much longer.
Already miles behind an accelerating inflation curve, once the Fed raises
short-term interest rates to appropriate levels, the housing boom will give
way to the housing bust, and job gains will become job losses. Given the
current nature of U.S. employment, the jobs the housing boom giveth, the
housing bust will surely taketh away.