Financial markets digested a heavy dose of financial data and developments this week that pushed bond yields higher and have the Fed poised for a rate hike next month.
The headline of the week was the employment report released Friday morning. Total nonfarm payrolls increased by 157,000 jobs in July, shy of expectations, but enough to send the unemployment rate to 3.9 percent, which is near its lowest level in almost 50 years.
Wages, a key indicator, increased in July with average hourly earnings increasing 2.7 percent over the same period a year ago. This is a good sign for workers as rising wages and low unemployment shows leverage is shifting in favor of the work force as employees are able to demand higher salaries. Rising wages also drives economic growth.
Of particular interest, the manufacturing sector added 37,000 jobs during July, pushing the industry to the best annual job gain in more than 20 years. Over the past year, U.S. manufacturing added 327,000 jobs, the most of any 12-month period since April 1995.
While manufacturing makes up a smaller percentage of the American GDP today (about 11.5 percent) than decades ago, the employment results are good news for economic health and a sign people are finding jobs in skilled production work.
Fed sees strong economy
Earlier in the week, the Federal Reserve held its monthly meeting, and while the central bank didn’t hike interest rates, it did change its official statement. Investors and analysts immediately noticed the Fed now labels recent trends in the economy as “strong,” which sets the stage for the third rate increase of the year next month.
“The labor market has continued to strengthen and economic activity has been rising at a strong rate,” the Fed said in its statement Wednesday.
The Fed has predicted it will raise interest rates two more times this year and three times in 2019. Wall Street expects the Fed to lift rates to a range of 2 percent to 2.25 percent at its next meeting in late September and then to a range of 2.25 percent to 2.5 percent at its meeting December. These would be the highest benchmark rates from the Fed in a decade, even though the range remains near historic lows.
With its mandate to keep full employment and inflation at a 2 percent annual rate, the Fed feels now is the time to normalize monetary policy after a decade of accommodative stances designed to jump start a weak economy. Inflation is now at its target rate, and employment conditions are equally strong.
In other Fed news this week, the central bank announced it would increase its sale of short-term government bonds. This is driven by the need to support increased deficit spending by the federal government. For investors, it’s also another indicator that interest rates could rise further. An influx of Treasury notes in the marketplace will eventually lead rates higher as investors demand higher yields on the bonds if supply outpaces demand.
The pace of these auctions is something to watch in the months ahead as federal deficit spending continues. Will economic growth lead to more tax revenue and less need to sell new bonds? Will investors keep a healthy appetite for bonds or demand higher yields?
The yield on the 10 year Treasury note briefly hit 3 percent this week for the first time in over a month, showing signs of another move higher. It has since settled just below the 3 percent threshold. Mortgage rates follow the yield on the 10Y Treasury.
On the trade war front, the Trump administration this week floated potentially higher tariffs on China than originally projected. Instead of 10 percent tariffs on $200 billion in goods, Washington suggested it could go as high as 25 percent on Chinese goods. This news, while only floated, immediately sent stocks lower. There remains a lot of uncertainty about how economic activity will be hampered if China and the U.S. can’t settle on a trade agreement.
This week also delivered a host of economic data, in addition to the jobs report, which mostly painted a picture of economic strength.
- The S&P/Case-Shiller home price index rose by 0.2 percent in May, in line with consensus expectations. The year-over-year increase is at 6.5 percent, and in April 18 of the 20 largest cities saw price gains. Only Detroit and New York slipped.
- The Conference Board index of consumer confidence increased in July to reflect improved household perceptions of economic conditions. The difference between the percent of respondents saying jobs are plentiful and those saying jobs are hard to get increased to 28.1, the highest level in 17 years and a signal that fewer Americans are having trouble finding work.
- Factory orders increased in June, and capital expenditures momentum appears solid in the middle of the year.
- Finally, let’s not forget to mention that second quarter GDP, announced last week, was 4.1 percent. That’s the highest quarterly number in five years.