Shocking Jobs Miss Implies Rates Will Stay Low for Even Longer
What You Missed: Long-term interest rates fell as equities rose amid a volatile week of changing economic fortunes. The yield on the benchmark US 10-year Treasury note dropped from 1.64% to 1.56% following a disappointing April hiring report on Friday morning. Short-term rates, like 1-month LIBOR and SOFR, barely budged, drifting near record lows. The price of a barrel of West Texas Intermediate crude oil rose to $64.84, as the US Dollar weakened, and Gold strengthened. Treasury yield volatility, a key driver of the cost of rate caps and swaptions, fell through the week.
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Hiring fell flat in April. April’s expected hiring boom did not materialize as nonfarm payrolls fell well short of estimates. Nonfarm payrolls came in at a paltry 266K as the reopening of the economy appears rife with frictions, such as skills-mismatches, parents unable to return to the workforce with a significant share of schools still closed, and incomplete vaccination efforts. The unemployment rate rose to 6.1% amid a shortage of available workers that is seemingly getting worse. In addition, the number of new jobs created in March was revised down to 770K from the originally estimated 916K, although new jobs in February saw an upward revision to 536K from 468K. The leisure and hospitality industry saw the biggest hiring gains, adding 331K workers, though that still left the industry nearly 2.9 million shy of where it was before the pandemic.
Our take: Well, it’s hard to call job growth of less than 200k (net of revisions) meeting the Fed’s hoped for “substantial further progress,” isn’t it? The “string” of job gains that Fed Chair Powell called a prerequisite for tapping the brakes on the Fed’s full-throttle stimulus efforts will now take longer to materialize, implying that market watchers must now dial back their late 2021 to early 2022 Fed tapering timeline.
Like we’ve said for weeks now, the Fed is totally focused on creating the perfect environment for job creation. The so called “jobs deficit,” or employment shortfall relative to pre-pandemic levels, is still wider than it was at the end of the Great Recession of 2007-09. The dynamic is front and center at the Fed and is the key threshold to be overcome – or at least dramatically reduced – before the Fed can declare “mission accomplished.” It’s time to ditch your inflated views of inflation; until the jobs deficit is eradicated, there is little reason to believe that the price surge in many commodities (e.g. lumber, gasoline) will be sustainable over the long run. At the end of the day, the job creation stumble gives the Fed even more runway before it will need to pull back the easy money/low interest rate punch bowl, implying that short term rates – like 1-month LIBOR and SOFR – will remain anchored near zero for even longer, and long-term rates – like the 10-year Treasury yield – can only rise so far.
Treasury Secretary Yellen’s faux pas spooked markets. Janet Yellen conceded that interest rates might have to rise to keep a lid on the burgeoning growth of the US economy brought on in part by massive government stimulus spending. The whoopsie, which occurred in an interview, threatened to undo the concerted efforts of Fed officials to persuade markets that it will be some time before the Fed eases off the gas pedal, let alone hikes rates. Inflation concerns have arisen due to the spending and the rapid growth, but Fed officials have said that after a brief rise this year, price pressures are likely to ebb. Yellen later clarified her initial statement by saying she is not particularly concerned about inflation becoming a problem, echoing the Fed’s siren call that any price increases during the recovery should be transitory.
Our take: Any hint that a less-easy Fed is on the immediate horizon would have major implications for markets. Higher interest rates would also be counterproductive for President Biden’s plans – Yellen has repeatedly highlighted how historically low borrowing costs today give the government greater scope to boost spending. Yellen’s comment came amid a debate on whether Biden’s raft of proposed and enacted government spending could spur a surge in price pressures.
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Perhaps you’re a believer that large spikes in the cost of many raw materials and labor shortages sparking wage inflation will ultimately persist far longer than the Fed believes. We get you, and you could be right about a wage-price spiral, where higher wages chase too few goods. If so, that doesn’t mean the Fed will hike interest rates to combat it, as it has stated over and over again that its “average inflation targeting framework” gives it the legroom to keep rates at ultra-low levels to ensure it achieves its “broad and inclusive” full employment goal. As the disappointingly weak April payroll figures demonstrated, it could take another few years to recover the ~7 million jobs needed to get back to the pre-pandemic levels of employment. Bottom line: Inflation should not be a concern until the jobs situation improves in a big way; in the meantime, the Fed is sitting on its hands.
What to Watch This Week: The days ahead are filled with a handful of important data releases, the most important of which is Wednesday’s consumer price data for April, which may show if stimulus checks and easing virus restrictions have pushed up demand for everything against a backdrop of tight supply. Even if the gauge shows a further spike in prices, it will be discounted because of the transient mix of demand-pull and cost-push factors inherent in the post-pandemic economic recovery.
Elsewhere, Friday’s retail sales data will show strong spending activity by consumers, but that the stimulus check-boost to purchases on new shiny things may be fading. Also on Friday, gauges of industrial production and consumer confidence should show that raw material shortages are slowing factory activity and consumer virus fears continue to slowly melt away, keeping the higher inflation theme well supported. Outside of data, there are several speaking engagements from Fed officials.
Big Picture: The U.S. job market is suffering from growing pains as the economy rapidly reopens. While economists are optimistic about future growth, it’s now clear that employers are facing hiring challenges as well as supply chain disruptions and higher costs. Expect fundamental factory production changes to the “Just-in-time” (JIT) strategy. The pandemic exposed the risk of JIT. The impact of a worldwide microchip shortage disrupted the supply chain well beyond cars. The dynamic will serve to keep prices in some goods dependant on this process – like some electronics – higher for longer.
How much weight should one put on a single month of jobs data? When most of the other evidence suggests economic activity is rebounding quickly, the poor showing of America’s job-creation engine last month is a clear reminder that the recovery in the jobs market is lagging the rebound in consumption. That’s a tough dynamic for the Fed to manage. With the number of jobs still ~7 million below their pre-pandemic levels and the number of new jobs created still only in the hundreds of thousands rather than millions, it will be a long time before the Fed can claim “substantial further progress” towards their “broad based and inclusive” full employment goal. That means any talk of tapping the brakes, let alone rate hikes, is further down the road than you believe.
For long term rates, the fall from their highs a few weeks back was driven partly by demand from Japanses investors such as pension funds switiching from foreign sotcks into foreign bonds. That investment portfolio re-balancing is now complete, and opens the door for economic data to drive long term rates. The re-opening of the economy, supply constraints, pent up consumer demand and excess savings will continue to boost growth and consumption in the near term, and long term yields with them if economic data suprises to the upside.
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Source: Bloomberg Professional
Source: Bloomberg Professional