The Market Today
May Jobs Report Strong; Italy Forming Government; Spain Has a New Prime Minister; Tariff Turmoil Escalates
by Craig Dismuke, Dudley Carter
Busy Calendar Covering Many Sectors: Today’s economic calendar is packed once again, starting with the May labor data followed by April’s Construction Spending (9:00 a.m. CT), May’s ISM Manufacturing Index (9:00 a.m.), and May’s auto sales data (throughout the day).
May Labor Data Solid, with Slightly Firmer Wage Growth: The economy added 223k total payrolls in May, beating expectations by 33k. In addition, March’s payroll report was revised up from 135k to 155k (+20k) and April’s report was revised down from 164k to 159k (-5k). The 3-month average for payroll growth fell from 208k to 179k. The private sector added 218k jobs in May while government payrolls increased 5k. Looking by sector, retail posted the most impressive month, adding 31k jobs (12M average of 10k). Information technology also beat its 12-month run rate adding 6k payrolls (12M average of -2k). The construction sector added 25k jobs while manufacturing added 18k.
In the household report, the unemployment rate fell from 3.93% to 3.75% as 293k more people reported as employed, 281k fewer people reported as unemployed, and 170k more people reported as not in the labor force. As such, most of the decline in the unemployment rate was due to job gains while part was attributed to slower-than-normal growth of the labor force.
Average hourly earnings were stronger than expected, rising 0.3% MoM bringing the YoY rate up from 2.6% to 2.7%. The earnings data has been the focus of the reports for over a year now with the markets responding primarily to this, and the implications for Fed policy. Stronger earnings implies more-stable inflation and a more confident Fed. Hours worked held steady at 34.5.
Bottom Line: The May jobs data is yet another solid report showing above-trend job growth, continued tightening of the labor market, and fractionally firmer wage growth. The report will encourage the Fed heading into its June 12-13 meeting at which time another 25 bps rate hike is expected.
Yesterday – Markets Couldn’t Catch a Break as Trade Tariffs Disrupted Waters Calmed by Easing Italian Political Turmoil: Thursday’s market focus shifted away from Italian politics to announcements regarding tariffs on trade flows between the U.S. and several of its largest trading partners. Just after U.S. markets opened, Commerce Secretary Ross disclosed that the U.S. would allow exemptions to steel and aluminum tariffs for the EU, Canada, and Mexico to expire at midnight. The exemptions had been extended through the end of May to allow more time for trade negotiations. However, Secretary Ross indicated that progress hadn’t reached a point to justify any further postponement. Stocks tumbled and remained lower as the various countries’ responses rolled in. European Commission President Juncker said the EU would retaliate with “counterbalancing” measures. Mexico and Canada both released lists of U.S. goods those countries would apply tariffs on in an attempt to match dollar for dollar the U.S. action. The response in the Treasury market was less linear than stocks. After an up-and-down day of trading the 2-year yield finished up 1.6 bps at 2.43%, the 5-year yield rose 1.5 bps to 2.70%, and the 10-year yield added a smaller 0.4 bps to 2.86%. Likely helping to absorb some of the blow, some of the uncertainty surrounding Italian politics was removed as Five Star and the League rejoined forces. Their prime minister appointee will be sworn in today.
Overnight – Lots for Investors to Take In: Global investors seem unfazed on Friday by several events that might normally be considered catalysts for caution. In addition to the return of tariff threats on Thursday, Spain’s Prime Minister was voted out before this morning’s U.S. nonfarm payroll report for May. Prime Minister Rajoy moved into the political crosshairs in recent days after several former members of his party were convicted of racketeering. He was shown the door after a successful no-confidence vote and replaced by Pedro Sanchez of the Socialist party. The rumblings in Spain are considered to pose less risk than Italy considering their generally pro-European stance and the numerous parties needed to support the new Prime Minister. Spanish stocks rose 1.9%. Italy’s MIB index rallied 2.4% to lead widespread gains across Europe after yesterday’s news that Five Star and the League successfully created a coalition to run the government. Ahead of the U.S. payroll report, U.S. equities and Treasury yields were both helped higher by the improved global sentiment. The 2-year yield was up 3.0 bps to 2.456 with the 10-year yield 4.2 bps higher at 2.90%. After payrolls beat, the short-end of the curve caught up with the long-end at +5.0 bps on the 2-year.
April’s Disappointment for Housing Continued in the Pending Sales Data: April was unfriendly to the trendlines in the key housing related reports. After data last week showed larger-than-expected declines for both new and existing home sales, the pending sales report did little to brighten the outlook. Pending sales fell 1.3% in April, worse than the modest 0.4% gain economists were expecting. New contract signings in the Northeast were flat after a steep 5.6% decline in March. Activity in the Midwest and South pulled back from improvements the month before and the West saw fewer deals MoM for a seventh consecutive month. A slower pace for pending contracts calls into question hopes for any positive momentum in the existing sales series in the months ahead.
Brainard Said U.S. Outlook May Warrant Modestly Restrictive Fed Funds Rate: Fed Governor Lael Brainard said the Fed should move forward with gradual rate hikes and indicated she may have one of the dots that puts policy on a path to a restrictive setting in 2020. A strong labor market and inflation hovering around the Fed’s 2% target “suggests a policy path that moves gradually from modestly accommodative today to neutral — and, after some time, modestly beyond neutral.” However, she pledged to “remain vigilant for the emergence of risks” and said she’s prepared to change her outlook if needed. She said “While it is difficult to know with precision how much [labor] slack still remains, I am seeing more evidence that labor markets are tightening, and wages are accelerating, although at a measured pace.” Fiscal stimulus in the pipeline could hasten the tightening and add to wage pressures and poses upside risks to the outlook. She cautioned, however, that global developments – she singled out trade flows, Italy, and emerging markets – posed some downside risks. Brainard said she’d be comfortable with a “mild, temporary overshoot of the inflation target” and noted the Statement’s forward rate guidance is “growing stale”.
Quarles Said Neutral Rate May Be Rising, Mester Sees More Gradual Tightening: Fed Randal Governor Quarles spoke briefly on CNBC saying that this outlook hasn’t changed and indicating he believes “there are reasons to think the neutral rate is rising.” He supports an open economy and said he doesn’t think the trade bickering has reached a point yet to have a significant macroeconomic impact. He also said what’s happening in Italy isn’t affecting his outlook noting that “Markets have been absorbing the news…reasonably well.” Loretta Mester from the Cleveland Fed agrees that Italy hasn’t changed the U.S. fundamentals. In remarks following Quarles, Mester said “Whether it’s three or four [total 2018 hikes], I know the markets want to know exactly that, but in terms of the economy and the macroeconomy, I think that is less important. I think the important thing is we need to be moving the funds rate up gradually because the economy is improving, and we’re getting at our goals.”