(Monday Market Open) It’s all about the Fed this week, and the market might be a little flat in advance of Wednesday’s announcement on interest rates. But even as Yellen and company prepare to gather, the buzz continues about Friday’s bullish jobs data.
Looking at the payrolls report again after the weekend, it’s hard to find flaws. The headline number of 235,000 was above expectations, and the government even revised upward January jobs creation to 238,000. The quality of jobs (construction, manufacturing, health care, education, business services) looked very good, and wage growth, while not amazing, came in at 0.2%, and is now up nearly 3% year-over year. That’s slightly above the headline inflation rate, and the Fed has been looking for signs of inflation.
Why was February a good month for jobs growth? Well, for one thing, the construction sector seemed to benefit from a warmer-than-normal February across much of the country. And construction momentum could continue if the new administration pushes through its promised infrastructure spending program.
There’s little doubt that the labor market is expanding (see chart below), and that American workers are starting to see some of the benefits in the form of higher wages. That might explain why the retail sector showed some muscle late last week, with consumer discretionary stocks outpacing the overall market. When Americans have jobs and more money in their pockets, they tend to spend it, and that could mean improved sales of cars, dishwashers, and other big-ticket items. However, retail jobs were one of the few sectors that slumped in the February report, so perhaps that tells a different story.
Investors could get a better sense of how quickly people are flocking to malls and car dealerships on Wednesday morning when the government releases retail sales data for February. Inflation data are due this week, as well, with the producer price index (PPI) on Tuesday morning and the consumer price index (CPI) on Wednesday.
As all these data arrive, the Fed will gather Tuesday and Wednesday to decide on rates. CME futures now indicate a nearly 90% chance of a rate hike. And looking further ahead, futures prices indicate that the chance of the Fed raising rates three times this year, as it promised, now stands above 50%. The bottom line is that the jobs report seemed to solidify the case for a March hike, and two to three more hikes could come as long as the economy’s momentum continues. The Fed may not want to let this opportunity slip by to get rates back toward normal and provide a longer runway if at some point it needs to lower rates in the event of an economic stumble.
But could rate hikes slow the stock market down? The prospect of higher borrowing costs may already be weighing on some sectors, including energy and real estate (see below). But from a big picture view, it looks like investors see the Fed’s expected move as confirmation of economic strength, and retain their optimism. That said, it wouldn’t be too surprising to see some additional profit taking at the lofty levels stocks currently trade at, just 1% below all-time highs.
And even though there’s optimism about the economy, it’s important to remember that strong jobs growth doesn’t tell the entire story. Some other recent data haven’t been as robust, and the Atlanta Fed projects Q1 economic growth at just 1.2%. That’s below Wall Street analysts’ consensus of around 2%, but either way, we’re not talking extraordinary growth numbers. It could be interesting to see if the Atlanta Fed number perks up a little this week in light of the jobs data.
Points for Participation? After bottoming out at 62.4% in Sept. 2015, the labor participation rate—the percentage of the civilian labor force over age 16 who are employed or looking for a job—has been on a slight uptrend, and on Friday re-touched 63%, the short term high set in March 2016. While the participation rate is unlikely to return to the postwar high of 67.3% set in 2000—Baby Boomers were still in their prime earning years back then and now 4 million of them are expected to retire each year for the next 20 years—any reading in the mid-60s would seem to indicate further normalization of employment activity. This may be a number to watch in the coming months.
Real Estate Brings Up Rear: The worst-performing sector over the last week has been real estate, which fell more than 3%. The sector is also down slightly year-to-date. Real estate is interest rate sensitive, and mortgage rates jumped to three-year highs last week, reflecting in part the recent rise in Treasury yields. A 30-year fixed rate mortgage now has an average rate of 4.21%, up from below 3.5% last summer, according to Freddie Mac. When mortgage rates rise, it can sometimes slow down the housing market, as well as homebuilders’ shares. And recent data show rising prices and low inventories posing a barrier to some prospective home buyers.
When Weakness is Good: Falling oil prices may have helped put a lid on stock market gains after Friday’s positive jobs report. But it’s also possible that in a sense, weak oil helped pave the way for the strong job and wages growth seen recently. It’s been more than two years since the price of crude oil collapsed from above $100 a barrel, where it had been pretty much since early 2011. In the two years since, oil has fallen as low as $26 and climbed as high as $60, but generally has traded in the $40s and $50s, delivering the American economy relatively low energy prices from a historic, inflation-adjusted perspective. Over the last 50 years, high oil prices have often been associated with recession (think 1973-74 or 2007-2008), while low oil prices have often coincided with boom times (the mid 1980s and late 1990s, for example).
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