Although the markets are much more focused on the brewing trade war, Friday's employment report had a lot to digest. Here are my thoughts along with some trade ideas.
What a difference a month makes!
This is the peril of reading too much into any given month's job report. In March, Non-Farm Payrolls increased by a measly 103,000, over 80,000 less than economists were expecting and over 200,000 less than February. Of course, that February number was a blowout on the other side, posting a 313,000 gain. So, basically we got about 200,000 job gains on average over the last two months, and we should probably just ignore the weird variation over the period.
That being said, the narrative that the job market was reaccelerating now seems off base. Payroll gains averaged 182,000 in calendar 2017 and 195,000 in calendar 2016. So far in 2018 we are averaging 202,000. I wouldn't call that a real acceleration.
Meanwhile, the Household Survey (used to calculate the official Unemployment Rate) actually showed an outright job decline of 37,000, coupled with a decline in the labor force of 158,000. That allowed the unemployment to stay at 4.1%.
Here again, we have a reversal of a popular narrative that emerged after the strong February report. That report showed more than 800,000 people re-entered the labor force, which had many suggesting that the slack is larger than we're assuming. That still could be true, but I think it is a lot more likely that we are at a plateau on Labor Force Participation. That figure has been in a range between 62.7% and 63.0% since the middle of 2016. I think we were just drifting toward the high-end of that range in February.
Does this affect the Fed?
It does affect the perception of the Fed for sure. Fed funds futures for December are suggesting a 3 basis points decline in fed funds. That's not earth shattering, but we're now 16 basis points off the high projected yield posted in mid-March, or more than half of a rate hike pulled back. The current implied fed funds rate for year-end is 2.07%, or barely more than one full hike.
However, I don't actually think it changes the Fed's view of things much. I still think the central bank is likely to hike two more times, including once in June, with the potential to hike a third time. Why? Because the Fed really doesn't react much to month-by-month numbers.
The Fed didn't change anything about its forecast based on February's strong payroll number, and hence it isn't going to change anything based on Friday's relatively weak number.
Ancillary signs of a tight labor market remain all over the place. Today's Average Hourly Earnings figure was in-line with surveys, but it's worth noting that it was materially stronger than February's read. This is just more evidence that the Fed's more even-keeled view of the labor market is the right one.
In fact, the Fed is going to be much more focused on the potential for a fiscal boost to cause inflation. Right or wrong, this is the kind of thing that drives its models. It will take several months before we the know how much it impacts the economy, which means the Fed is likely to push a more hawkish message for a while to go.
What about this trade war stuff? Doesn't the Fed care about that?
The Fed's economists are ardent free-trade advocates to be sure, but I don't think they are likely to change their monetary policy stance. The main reason is that the kinds of goods that are being affected by the various tariffs probably won't impact inflation at all.
Even if steel prices rise by 25%, the amount of actual consumer goods impacted is small in the scheme of the economy. Plus, there could be mitigating effects.
Some of the increase in input prices might just be eaten by producers and not passed on to consumers. Some prices might rise resulting in consumers spending more on one good and less on another good. Any of this would result in a very modest, if any, effect on overall inflation.
I also don't think the Fed wants to be seen as cushioning the blow of a bad policy, which is exactly what easing up on hiking would do.
What trades do I like?
I have been net long Treasuries for a while now, and it is finally starting to work. I will remain with that trade until the 30-year Treasury gets to 2.71% (next resistance point), then I will revisit. We briefly got close last week until rebounding.
Meanwhile, pressure on short-term bonds has eased up as people have walked back Fed expectations. That's a mistake. The Fed is just as convinced about hiking two more times, and as we get closer to June, I think that will become more and more clear to the market. I'm short 2-5 year bonds paired with long 10+ year bonds.