Today's non-farm payroll data showed another month of solid job gains: the US economy added 215,000 jobs in March which was ahead of expectations of 205,000 jobs created. The 2 month net revision was only -1,000 jobs. Accompanying data releases also supported an improving labour market: the unemployment rate edged up to 5% but the participation rate also increased to 63% from the prior month’s reading of 62.9%. Average hourly earnings figure edged up to 2.3% yoy from the prior reading of 2.2% while average hours worked was unchanged from the prior month’s figure of 34.4 hours.
Recent commentary from Janet Yellen, the Fed Chair, has emphasised patience in raising rates and indicated she is unconvinced by the strength in the core PCE data of late stating, "I haven't concluded that we have seen any significant uptick that will be lasting." Moreover, she has noted, "market based measures of longer-run inflation compensation have fallen markedly over the past year and half, although they have recently moved up modestly from their all-time lows. Similarly, the measure of longer-run inflation expectations reported in the University of Michigan Survey of Consumers has drifted down somewhat over the past few years and now stands at the lower end of the narrow range in which it has fluctuated since the late 1990s."
It came as little surprise that the FOMC has recently scaled back its 'dot plot' to two rate rises from four in 2016, although even this still looks optimistic as at the time of writing the futures market is pricing in only a 28% chance of a rate hike in June but 60.9% by year end. The FOMC’s forecasts are based on the assumption that ‘economic headwinds’ will fade and a gradual increase in the neutral rate will then be required. Janet Yellen has noted that the neutral real rate, ”the level of the real federal funds rate that would be neither expansionary nor contractionary if the economy was operating near its potential--is likely now close to zero.” Although “the current real federal funds rate is even lower, at roughly minus 1-1/4 percentage point, when measured using the 12-month change in the core price index for personal consumption expenditures (PCE).” Hence the current policy stance is consistent with “economic growth modestly outpacing potential growth.”
Nevertheless, US growth remains patchy and uneven; aside from the obvious weakness in the manufacturing sector, US real median household income has declined since 2007 reflecting rising income inequality and ‘external conditions’ have been unsupportive. This implies the Fed can afford to be 'patient' in raising rates. Downward revisions to the US’s potential output growth combined with ‘external headwinds’ and a Fed acting ‘ahead of the curve’ should support Treasuries at the long end (on a duration weighted basis) and make high quality quasi-sovereign issues from 'wealthy nations', which offer a generous spread over Treasuries, look compelling value.