Employment Report Disappoints
The May Employment Report has provided further evidence that the economy has downshifted in the second quarter of 2019. New job creation came in well below economist estimates, increasing only 75,000 in May, adding the fewest new jobs in 3 months. March and April figures were revised lower by 75,000. The unemployment rate held steady at a 49-year low of 3.6%. Wage growth slowed a bit.
Investors are particularly concerned by the May report because the weak numbers were recorded before the latest escalation in trade tensions with China and now Mexico.
Calls for Rate Cuts are Amplified
Financial markets are looking for two or three policy rate cuts in 2019 and a total of four by December 31, 2020. Futures markets have a July cut priced in.
Bond yields are falling as concerns for economic growth escalate. The inverted slope of the yield curve now places 3-Month T-Bill Rates above 10-Year Treasury Yields, an ominous sign.
“Markets (and the Fed) Take the Stairs Up and the Elevator Down.”
I came across this adage reading Barron’s this morning. The graphic below illustrates the truth behind it. The graphic depicts 2-Year Treasury yields and Fed Funds from 2007 through today, June 7, 2019.
Several Observations Prove Useful
The last elevator ride down began in December 2007 with the Fed Funds Rate at 5.25%. The ride ended 15 months later with the policy rate at .25%, a drop of 500 basis points. The elevator remained stranded in the basement for 7 years.
The Fed Open Market Committee (FOMC) began a slow climb up the stairs in December 2015 and was gassed by December 2018. The climb took 3 years with an elevation gain of only 225 basis point. Policy rates topped at 2.5%.
The final observation, market yields lead policy rates in the elevator and on the stairs. This market activity is evident throughout 2007 on the way down and again in 2014 through 2018 on the climb up.
Two-Year Treasury yields peaked near 3% in December 2018 with the Fed on auto-pilot, raising rates 9 times. Political pressure and a stock market swoon pushed a complacent Fed to reconsider its aggressive policy stance.
Today, 2-Year yields are trading 65 basis points below the Fed’s policy rate. The Fed publicly is entertaining scenarios that would predicate a rate cut with St. Louis Fed President Bullard calling for an immediate cut.
Confidence in trade policy and economic expansion has clearly been shaken. The bond market has ratcheted lower to a new trading range. The 3% yields of late 2018 are unlikely to return anytime soon.
Are we done climbing the stairs to higher policy rates? Yes!
Is an elevator ride in our near future? That will depend on trade policy and economic performance. The Fed appears ready to move should the bellman ask, “going down?”
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