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Monday, April 24, 2017

Financial Focus column - Jobs and Rates Take a Drop

Job growth and the Fed – two of the most powerful influences on the market over the past few years – both grabbed the spotlight recently. The stock market has ticked down modestly but with equities up 11% since early November, it's not particularly surprising to see the market take a bit of a breather. It was a reminder that
  • The luster of the so-called Trump rally won't shine as brightly forever;
  • Despite the preponderance of encouraging economic data in recent months, every reading or report won't exceed or even meet expectations; and
  • There are credible risks in this otherwise opportunistic environment that will be the source of periodic volatility as we move into the summer.
Where'd the Jobs Go?
The freshest reading of the U.S. labor market in the form of the March employment report was released. Here are the details:
  • 98,000 new jobs were added in March, a notable slowdown from January and February. Consensus expectations, according to Bloomberg, were for a gain of nearly double that figure.
  • The unemployment rate dropped to a decade-low 4.5% as hiring outpaced new entrants coming into the labor force.
  • The measure of underemployment (known as the U6 rate, which includes those that are employed but would prefer full-time work over part-time along with discouraged workers that have dropped out of the labor force but would like a job) fell below 9% for the first time since 2007. This measure was 14.5% at this time five years ago.
At first blush, these results appear quite weak, with hiring coming in well below expectations. This sparked concerns of a potential deceleration in the jobs market. We acknowledge that the March figures were disappointing, but we think it's premature to suggest the labor market is faltering. A closer look at the data along with a wider view of employment conditions yields a more constructive perspective:
  • Job growth was particularly strong in January and February, helped by unseasonably warm weather. March's job gains reflect some giveback, particularly in weather-sensitive construction hiring.
  • The broader trend is still quite healthy, with the three-month average for payroll gains still at nearly 180,000. One soft month a trend does not make. Last May, 43,000 jobs were added, followed by an average of 294,000 over the next two months.
  • There's more to the health of the consumer than just job growth. In fact, with more than 15 million jobs created in this expansion, we think the next leg of job-market support for consumers will come in the form of wage growth. Encouragingly, average hourly earnings rose 2.7% (year-over-year) in March. This brings average wage growth over the past six months above the 2.7% level, much stronger than the 2.0% average from 2010-2015.
The Fed Is Raising Rates; Someone Forgot to Tell the Bond Market
10-year interest rates fell to as low as 2.32% last week, receding from the 2.60% level reached in March after the Fed announced its second rate hike in the span of three months. The Fed was back in the market spotlight this week because the release of its meeting minutes showed that committee members have been discussing not only raising short-term rates, but also potentially reducing the size of its balance sheet (its ownership of bonds it purchased as part of its quantitative-easing stimulus strategy). We'd offer the following takeaways:
  • It might seem counterintuitive that rates would be pulling back at a time when the Fed has announced its plan to continue raising its target rate. In our view, it's more important to look at the path for rates over the broader term. We think U.S. rates will move higher gradually over time, but not in a straight line. Stock market jitters, ebbs and flows in inflation expectations, and adjustments in the interpretation of future Fed policy will cause rates to fluctuate up and down in the meantime.
  • The fact that the Fed is discussing next steps, such as reducing its bond holdings, is a good thing. While an overly aggressive approach to rate hikes could run the risk of undercutting the economy, equally if not more risky would be for the Fed to become complacent or caught flat footed. A measured approach to tightening monetary policy is one that can coexist with an ongoing bull market for stocks. But if the Fed were to fall too far behind the inflation curve (by, for example, not exploring or preparing future strategies for withdrawing stimulus), the market outcome could be detrimental. The market appeared a bit surprised by the fact that the Fed minutes showed it's discussing a reduction to its balance sheet this year, perhaps sooner that most anticipate. We don't, however, think this means the Fed intends to unwind six-plus years of stimulus immediately.
All told, we think the foundation of the bull market in stocks remains intact. The economy is growing, corporate earnings are rising, and the interest rate environment remains relatively favorable. But the path ahead is likely to be choppier as Fed policy, the execution of the Trump administration's pro-growth reforms, and geopolitical risks (such as the emerging situation with Syria) will serve as instigators of market volatility.

This article was written by Edward Jones for use by your local Edward Jones Financial Advisor, which in Prescott is Neal Robinson at 1400 N. Acres Dr. Suite 55

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