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Hello jobs, hello rate hike

Brian Nick, Chief Investment Strategist, TIAA Investments


March 10, 2017

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Quote of the week

“Heigh-ho, heigh-ho, it’s off to work we go…” — Snow White and the Seven Dwarfs (1937)

The Lead Story: Strong employment report should seal the deal for March rate hike

Another 235,000 people were added to the nation’s payrolls in February, according to the Labor Department’s monthly employment report, released on Friday, March 10. This strong showing beat consensus expectations of 200,000, and revisions for the prior two months were slightly positive. The unemployment rate edged down to 4.7% from 4.8%, and wages continued to grow at a “Goldilocks”-like 2.8% annual rate. Importantly, the U-6 “underemployment” rate—which includes discouraged workers and part-time employees unable to find full-time jobs—dropped to 9.2% from 9.4%, as labor force participation ticked up to 63%, matching its highest level in three years.

Brian Nick, Chief Investment Strategist, TIAA Investments

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Article Highlights

Job creation has continued at a healthy pace despite the advanced age of the U.S. economic recovery, now in its eighth year. The cumulative progress made by U.S. labor markets has laid the groundwork for the Federal Reserve to get on with raising interest rates at a steadier pace, beginning this month. For perspective, consider that Janet Yellen took the reins as Fed Chair in early 2014, after the winding down of quantitative easing (QE) had already been set in motion. Instead of raising rates immediately after QE ended, Yellen held off, believing the Fed could induce more people into the labor market, adding jobs without stoking inflation.

The Fed maintained that stance in September 2015 when the unemployment rate fell to 5% (the level at which higher inflation normally kicks in) by raising rates only twice over the next 18 months. During that period, the unemployment rate barely inched downward, but more than three million workers were added to payrolls. Meanwhile, inflation remains modestly below the Fed’s 2% target. In other words, Yellen’s approach appears to have paid off. Against this backdrop, our current base case calls for the Fed to hike rates on March 15 and then two more times over the balance of 2017, consistent with the market’s view.

In other news: Treasury yields up, oil prices down

After an initial bounce following the release of the February jobs report, U.S. equity markets were off their best levels later in the day on March 10. The S&P 500 Index ended the week down 0.4%, breaking a six-week winning streak. In Europe, the broad STOXX 600 Index was also slightly lower, essentially unmoved by the European Central Bank’s March 9 announcement that it will maintain its monetary stimulus policies even with an improving economic outlook and upwardly revised expectations for Eurozone inflation.

Outside of equity markets, we saw a sharp drop in oil prices and a renewed rise in U.S. Treasury yields. The West Texas Intermediate (WTI) crude oil benchmark tumbled more than 9% for the week, finishing below $49 per barrel—its lowest level since November of last year. Why the selloff? Concern about rising supply. According to the U.S. Energy Information Administration, domestic crude inventories rose by 8.2 million barrels for the week ended March 3, their ninth consecutive weekly gain. Meanwhile, some domestic producers have hinted they will increase output, and U.S. oil rig counts have climbed steadily from their 2016 lows.

As oil prices were falling, U.S. Treasury yields were rising. On March 9, the yield on the bellwether 10-year note closed at 2.60%, its highest level since mid-December, before settling at 2.58% to end the week. U.S. and global economic data releases were generally favorable, and the view that we are entering a more robust global economic recovery gained further traction. Flows continued to be supportive of emerging-market debt and investment-grade corporate bonds, but high-yield bonds suffered outflows. Flows were positive for floating-rate loans, however, as a hedge against higher rates.

While demand for higher-yielding, non-Treasury sectors has remained mostly stable, spreads—the difference in yields offered by these sectors relative to Treasuries—are no longer narrowing as they were for most of the post-election period. Without narrower spreads contributing to total returns, and with gathering steam in the economy reminding us that interest rates should rise further this year, the outlook for fixed income is somewhat mixed. We expect consumer-oriented bond sectors to perform well amid upbeat confidence numbers and resilient labor markets, though retail and retail-related real estate issuers will likely benefit less from stronger consumer spending due to overcapacity versus e-commerce. We believe it’s appropriate to favor credit sectors over government debt; shorter-duration and floating-rate securities also remain attractive in light of three projected Fed rate hikes this year.

Current updates to the week’s market results are available here

Below the fold: Indicators you may have missed

While February’s jobs report claimed the lion’s share of the week’s headlines, other data releases are worth noting. Among them:

Back page: Is a manufacturing rule of thumb ready to play out?

On March 1, the U.S. manufacturing index published by the Institute for Supply Management (ISM) hit 57.7, its best reading since August 2014. (Readings above 50 indicate expansion.) While manufacturing is not as large a part of the U.S. economy as it once was, this measure is still considered a bellwether for growth and, in some cases, the U.S. equity market. Going back to 1990, the ISM index has climbed to 57 or higher on seven occasions. In all of those instances but one, the S&P 500 rose by at least 10% in the subsequent 12-month period. (The lone exception: August 2014, which immediately preceded a 50% drop in the price of oil.) Rules of thumb don’t always work, but history shows a humming manufacturing sector certainly hasn’t been bad for stocks.