Today’s January non-farm payroll release showed 227,000 jobs added which was above expectations of 180,000 jobs created although the prior month’s reading was revised up by only 1,000 jobs to 157,000. The unemployment rate edged higher to 4.8% from December’s reading of 4.7% along with the participation rate which increased to 62.9%. Importantly, average hourly earnings grew 2.5% yoy, down from the previous month’s figure of 2.9% yoy, and below expectations of 2.8% yoy.
The Fed’s December projection is for 3 hikes in 2017 and 2 in 2018 but considerable uncertainty remains in terms of how much tightening will be required given a lack of policy detail from the Trump Administration. The January Fed meeting statement made no policy change with a somewhat dovish stance emphasising a gradual data dependent approach to tightening. Given the asymmetric risks that tightening too aggressively brings and a lack of policy detail from the Trump administration it comes as little surprise the Fed is exerting some caution. Thus, the Fed futures are discounting a 69.5% probability of a hike by the June meeting.
The US economy grew 1.9% in 2016 based on the latest Q4 data keeping the economy set in the ~2% trend that has been the case since 2010. So far, we see little evidence to convince us that growth can sustainably be boosted back above the 3% level as the structural trends of poor demographics, secular stagnation and elevated global debt levels remain firmly entrenched. It will be interesting to see how the US debt ceiling negotiations progress in March as an indication of scope for a more expansionary fiscal policy. Even if there is a boost from Trump’s stimulus and tax cuts that is not more than offset by a more protectionist trade policy the effects are unlikely to impact until 2018. A stronger dollar will remain a drag on both growth and inflation.
While there is some pick-up in inflation it still remains below the Fed’s 2% longer run objective, although they expect it ‘will rise to 2% over the medium term’: the Fed’s preferred measure of core PCE prices at 1.4% Q4 SAAR is on the low side and the ECI (Employment Cost Index) report showed that wage growth remained sluggish rising 0.5% in Q4 giving a 2.2% yoy rate. Sentier Research’s work on US household income (which uses monthly data from the Current Population Survey ‘the source of the nation’s official statistics on employment and unemployment’ to give monthly updates) also suggests a sluggish outlook for real median household incomes. The January 2017 Report commented: ‘Median annual household income in December 2016 ($57,827) was 0.9% lower than in December 2015 ($58,356), but 9.1% higher than in August 2011 ($53,019). This general upward trend since August 2011 reflects, in part, the low level of inflation as measured by the CPI for all items used in this series, as opposed to the CPI less food and energy. However, energy prices recently have been on an upswing, contributing to the 0.3% increase in the CPI for all items between November 2016 and December 2016, and playing a significant role in the reported decline in median income this month.’ The report notes the December real median income is not ‘significantly different’ from levels at the beginning of the GFC in December 2007 ($57,886) and is 1.3% lower than the level in January 2000 ($58,574).
We expect that the Fed will remain ahead of the curve in the process to normalise rates and the yield curve is likely to flatten. US Treasuries have already factored in a significant amount of policy tightening with the 10 year yield having backed up 110 basis points from the July 2016 low of 1.36% to ~2.46% at the time of writing. Against such an uncertain global backdrop a portfolio of high quality bonds from creditors, particularly those offering positive yields, remains one of the most attractive places to be positioned.