May Jobs Report Shows Strength
Economists were anxious to see the May jobs report from the Bureau of Labor Statistics (BLS) to see how jobs would rebound from a dismal March and a decent April. The estimates were, in the words of USA Today, “all over the map.” UBS and Bankrate.com were expecting 200,000 new jobs, the Bloomberg median estimate was 220,000 new jobs, and Capital Economics predicted 280,000 new jobs.
Congratulations to Capital Economics. The economy did add 280,000 jobs in May, and the disappointing March jobs reading of 85,000 jobs was revised to a final value of 119,000. Non-farm wages also rose eight cents to $24.96, the greatest year-over-year rise since August 2013, and the unemployment rate was 5.5% — "essentially unchanged" by BLS standards. The report prompted James Marple, senior economist with TD Bank, to proclaim it "picture perfect."
That description may be a bit much, but pessimists will have to dig pretty deep to find reasons to complain. Stocks even avoided the typical overreaction. The Dow fell 56 points to continue a sinking trend, the S&P fell slightly and the NASDAQ finished up for the day. The only intense reaction was in the bond market, where yields were up sharply to 2.43% in anticipation of a future rate hike by the Federal Reserve.
Healthy Numbers Throughout
Other indicators in the report were either positive or neutral. There were healthy job increases in the higher-paying fields of professional and business services (63,000) and healthcare (47,000). Jobs in leisure and hospitality (57,000) and retail (31,000) also grew significantly. The only poor results were in mining, which is still feeling the hit from the global oil price collapse.
The slack in the labor market appears to be slowly dropping as well. While the unemployment rate ticked up to 5.5%, the labor participation rate is up to 62.9%, back at the upper end of the 62.7%-62.9% range it has been stuck in for over a year. Meanwhile, the U-6 unemployment rate that includes underemployed workers and those marginally attached to the workforce stayed constant at 10.8%.
Economists believe workers are finally being drawn back into the workforce, albeit slowly, and that economic conditions are finally nearing the point where the Fed will act. David Kotok, chief investment officer with Cumberland Advisors, offers the prevailing opinion: "The Fed is still on track to make the first rate hike before the end of the year."
However, one strong voice is urging against Fed action — and it's not a domestic voice.
The IMF Weighs In
Christine Lagarde, the Managing Director of the International Monetary Fund (IMF) suggests that without any significant rise in inflation that "the economy will be better off with a rate hike in early 2016." Core inflation has been running at a low 1.2% over the last 12 months, and the IMF projects that it won’t hit 2% (the Fed's target value) until 2017.
From the IMF perspective, Lagarde's statement isn't surprising. The IMF remains concerned about the strength of other major economies, and may face a European crisis if the Greek debt situation leads to a default or a pullout from the Eurozone. The last thing the global economy needs is for Fed overreaction to squash the American recovery.
There is also reasonable concern about effects similar to the "taper tantrum" in 2013, when the mere suggestion that the Fed would taper its securities purchases rocked the markets. However, that same hair trigger has been periodically bleeding off the pressure with constant fluctuations and arguably preventing overvaluation bubbles. Consider that the 2013 taper tantrum wiped out $1.5 trillion in the fixed-income market over just two weeks, while the most recent bond selloff since mid-April has resulted in $860 billion in bond market losses (values from Bloomberg).
Remember the words of William Dudley, president of the New York Fed and considered part of Janet Yellen's inner circle: "After all, several times during this expansion, we have been fooled by sharp rises in the growth rate that appeared to presage a sustained pick-up, but subsequently proved fleeting." Translation: Give us a few decent jobs reports in a row and rates will rise later this year as most everyone expects.
While the Fed is not going to base their decision on the IMF's opinion, they probably won't ignore it, either. A September rise in rates is more likely given this report, but thanks to the state of the overall global economy and potential for chaos in the Eurozone, it is not a foregone conclusion. It's worth keeping an eye on the global economic picture to see how any monetary policy changes can affect America's short-term economic health — and therefore, the Fed's decisions.
Given that a rate hike will inevitably occur, now is a good time to review your holdings assuming the Fed will act later this year with a small hike. How will they hold up to an interest rate hike? Do you have disproportionate bond holdings or interest-rate sensitive utility stocks? We don't necessarily suggest you jettison them — stick with your diversification plan, but consider interest-rate sensitive holdings as higher risk than usual while you re-evaluate and rebalance your portfolio.
Consider implementing your adjustments over the next few months, and keep an eye on jobs reports and world economic events leading up to the September Fed meeting. At some point in the next six to twelve months, it seems likely we'll get to see a real interest rate hike, instead of the mere threat of one. It will be interesting to see whether the reaction is different between the two.