Today’s non-farm payroll data release for May recorded 38,000 jobs added which was well below expectations of 160,000 and compares with a downwardly revised 123,000 jobs added in April. The two month payroll net revision was -59,000. The 3 month average for job creation is now running at only 116,000 jobs. The unemployment rate fell to 4.7 percent however the participation rate edged down to 62.6 percent. Average hourly earnings was unchanged at 2.5 percent yoy against expectations of a 2.5 percent yoy increase and average hours worked edged down to 34.4 from 34.5 the prior month.
At the start of May the Fed Futures were implying only a 4 percent chance of a Fed rate rise but commentary from the Fed speakers has made the market reassess this view with the Fed Futures market discounting 22 percent chance of a June rate rise and 54.8 percent for July ahead of today’s data. Following today’s figures market expectations (at the time of writing) have moved to a 6 percent chance for June and 34.2 percent for July.
Job creation has been one of the strongest data points on the US economy but today’s data also showed signs of weakness. However, this month’s numbers also carry the distortion of a Verizon workers’ strike which the Labor Department estimates idled 35,100 workers. Janet Yellen’s recent speech stating it would “probably” be appropriate to raise rates “in coming months” has given the Fed flexibility to continue to observe how the economy performs and that the recent weaker employment data does not form a trend. That said, recent data points on consumption have trended a bit stronger and the inflation data, although still benign, has been edging higher: in April the core PCE was 1.6 percent yoy and CPI ex food and energy was running at 1.1 percent yoy. Janet Yellen has stated that she expects inflation will move back towards 2 percent by the end of the year, in-line with the Fed target.
The OECD June 2016 Economic Outlook describes the global economy as being stuck in a “low-growth trap” and it revised down its US 2016 growth estimate to 1.8% from 2% and held its 2017 estimate at 2.2%. We also expect anaemic growth and expect the trajectory and pace of any US interest rate rises to remain extremely gradual and that the neutral Fed Funds rate will be low by historical standards. Charles Evans, President of the Chicago Fed, noted in a recent speech that expectations for longer-run potential growth in the US have slowed: “As recently as January 2012, FOMC participants assessed the long-run potential growth rate of the economy to be around 2-1/2 percent. Today, the median FOMC participant believes that longer-run real GDP growth is only 2 percent.” Like us, he argues that trends of “aging populations, lower productivity, greater propensities to save, increased demand for relatively safe assets and declining real equilibrium interest rates are worldwide phenomena….likely to persist into the future, leading to lower potential growth for the overall world economy and lower real interest rates at both the short and long ends of the yield curve.”
If US data supports another rate rise over the summer period we expect the Fed will remain ‘ahead of the curve’ and the yield curve will flatten favouring positioning at the long end on a duration weighted basis. Importantly, when over USD10tn of government bonds trade at negative yields, high quality Eurobonds offering positive yields, particularly from creditor nations, continue to look compelling investments.