Today’s October non-farm payroll release showed 161,000 jobs added which was below expectations of 175,000 jobs added. The prior month’s reading of 156,000 jobs added was revised up to +191,000. The unemployment rate edged lower to 4.9% from September’s reading of 5% although the participation rate also fell to 62.8%. Average hourly earnings came in above expectations at 2.8% yoy up from 2.6% yoy in September.
This follows the US Q3 GDP release which looked strong at the headline number of 2.9% quarterly annualised but the underlying data painted a weaker picture. Inventory build was a major contributor increasing from -1.2 percent in the prior quarter to 0.6 percent in Q3. Net exports were also strong contributors giving a 0.8 percent contribution reflecting a surge in soybean exports on the back of a disappointing harvest in Argentina. Final domestic demand was subdued at 1.4 percent quarterly annualised. Business investment remained weak and below expectations growing at 1.2 percent.
We would also note that the September durable goods orders do not bode for a particularly strong Q4 either. More anecdotally, Doug Oberhelman, the Chairman and Chief Executive of the global economic bellwether Caterpillar noted ‘Economic weakness throughout much of the world persists and, as a result, most of our end markets remain challenged.’ More specifically the company noted ‘construction activity and construction equipment sales in North America during the second half of 2016 are now expected to be lower than they expected in the previous 2016 outlook’. Caterpillar has cut its 2016 profit estimate for the third time this year and sees little sign of a recovery expecting 2017 revenues to be similar to 2016.
The Fed’s own updated GDP projections from September seem consistent with a lower normal for growth: the median forecast for 2016 GDP growth is 1.8 percent, edging up to 2 percent in 2017 and 2018 and back down to 1.8 percent in 2019. Importantly, the median estimate of the long-run normal rate of GDP growth was cut to 1.8 percent from 2 percent in June. Inflationary pressures also remain benign in the sense that they are below the Fed’s target: the Q3 employment cost index remained benign at 2.3% yoy as did the Fed’s favoured inflation indicator the September core PCE at 1.7% yoy.
As William Dudley, President of the New York Fed, noted in a recent interview with the Wall Street Journal ‘When the economy is growing just a bit above trend and the labor market’s tightening only slowly and inflation’s below your 2% objective, there’s not a lot of urgency to tighten monetary policy quickly. The fact that the unemployment rate has been flat this year, even despite payroll gains of 175,000 a month, also argues for not a lot of urgency to tighten monetary policy. …..The fact that the neutral federal-funds rate seems to be very low today, that means that the gap between where we are in terms of the nominal federal funds rate we have today and what’s neutral isn’t that large.’
On the back of today’s solid set of employment data we expect that the Fed will remain ahead of the curve and raise rates in December; the futures market is now implying 76 percent chance of a rate hike in December. That said, the market is positioned for a Hillary Clinton election victory. But the key point is that any interest rate increases are likely to be extremely gradual; many of the forces that have been driving neutral rates to lower levels will remain entrenched anchoring interest rate expectations at the long-end of the curve where we favour positioning. We expect the yield curve will flatten from here.
High levels of uncertainty in global markets makes high quality bonds from creditors, particularly those offering positive yields, one of the most attractive places to be positioned.