Great Labor Report

In this article, I will review the latest jobs report. I will then explain what it means for the market and monetary policy. As you can see in the chart on the right, the Bureau of Labor Statistics reported the non-farm payrolls employment increased 235,000 which beat the upwardly revised expectations for 200,000 jobs created. As you can see from the chart on the left, the unemployment rate fell from 4.8% to 4.7%. Average hourly earnings grew 0.2% month over month which missed expectations for 0.3% growth. Year over year hourly earnings grew 2.8% which met expectations.

February was helped by unseasonable warm weather. This boost from warm weather may reverse itself in March as it looks like a major snowstorm will hit the east coast next week. Because Q1 GDP growth is expected to come in at 1.2%, a weaker March unemployment report would make the Fed look like it has egg on its face after it hikes rates on the 15^th. The tone of the market determines whether it gives the Fed a break. If there’s a bullish bias, bad reports are glanced over and described as one-off events; if there’s a bearish bias, investors may look at the two negative data points and extrapolate that the economy is slowing.

Oil fell over 1% to a 48 handle on Friday. On CNBC, a journalist asked the traders if oil price declines were bad news for the stock market. In describing how lower oil prices won’t hurt the stock market, the trader stated everyone knew the economy was strengthening; the traders all agreed. Traders extrapolate the positive stock market as a signal the economy is strong, but that’s a misnomer. The economy is currently weak, but is widely expected to strengthen because of an infrastructure plan, tax cuts, and regulatory cuts. I have recognized this change in current circumstances by looking at the economic reports which have caused most investment banks and the New York and Atlanta Fed to all downgrade their Q1 GDP growth forecasts. The stock market hasn’t factored this into the equation.

Heading into this jobs report, I was expecting it to be strong because the jobless claims in February were strong and the ADP private sector jobs report was strong. As I said, the snowy March could be a negative factor on the next labor report. Another negative factor could be the latest jobless claims report. Thursday’s jobless claims report increased 20,000 from the cycle low of 223,000 which was seen last week. I’m not saying the labor market is anything but strong, however, when the situation goes from great to good, it will be a negative for equities.

The seasonably cold weather in March will hurt retailers which already had a weak February. Retail trade was the only industry that hemorrhaged jobs in February. As you can see in the chart below, most industries showed strong jobs growth in the February report. Department stores like Macy’s and JC Penny are already getting hurt by Amazon. There is a potential double whammy that may occur if the border adjusted tax is enacted. However, I have been discussing the possibly that the GOP’s agenda may be delayed. While that’s a negative for most stocks, it may help retailers because it means the potential consumption tax will be put off.

Besides the headline number which was great and the hourly earnings growth which slightly disappointing, my main takeaway from the BLS report is the increasing number of people who are re-entering the workforce. The labor force participation rate increased from 62.9% to 63.0%. That is a bigger increase than it sounds like when you dig into the numbers. As you can see from the chart below, the number of people not in the labor force fell by 176,000 to 94.19 million which is the lowest since April 2016. Combined with January’s 736,000 drop, this makes the two-month drop 912,000, which is the largest two-month drop ever.

The chart below breaks down the labor force participation rate among various age groups. The 25-34 age group has shown notable improvement. This slack in the labor market makes it clear that the labor market is not as tight as the 4.7% unemployment rate makes it seem. Workers coming back into the labor market from the sidelines may slow down wage growth. I think it’s much more important to get discouraged workers a job than to grow overall wages. Too much wage growth can cause inflation, while there’s no negative side-effect to a new worker getting a job.

The 10-year bond yield fell about 3 basis points in response to this labor report. I think the positivity was already priced in. Given the strong ADP report, the BLS report could have been better. This may be the case of selling the rumor and buying the news. It’s the reverse for bonds compared to stocks because selling bonds and buying stocks is a ‘risk on’ trade.

The CME Group Fedwatch tool shows the chances of a rate hike in March increased from 88.6% to 93.0%. The probability of a rate hike in June increased from 45.4% to 55.4%. Goldman Sachs also sped up its expected timetable for the start of the Fed unwinding its balance sheet from mid-2018 to Q4 2017. The initial pop of optimism from the GOP’s fiscal policy is now about to be met with the monetary medicine which has been put off for a few years. The fiscal policy will need to boost growth to counteract this potentially new hawkish Fed.

Personally, I don’t believe the Fed unwinding its balance sheet is possible. I take the approach of ‘I’ll believe it when I see it.’ The Fed’s rate hikes could start to impact the economy before tax cuts start to work their magic. According to Mitch McConnell, the earliest tax cuts will come is October. The Fed will have raised rates twice by then if it keeps to this new schedule expected by the market. The chart below shows past examples of the negative consequences rate hikes have had on the economy. I must see how the economy and markets react to the hike in March before coming close to expecting the Fed to start selling bonds in Q4.