May 4, 2018

Stocks opened slightly lower but immediately spiked in early trading. The Dow is currently up 290 pts and the SPX is up 1%. All eleven major market sectors are in the green, led by tech (+1.5%), materials (+1.4%) and consumer staples (+1.3%). Price action suggests this is pretty clear risk-on trading session. The exception is staples (considered more risk-off defensive) which is just too cheap after falling more than 13% this year. The VIX Index is down around 15. Gold is down. The dollar is stronger and yet oil is sharply higher ($67/barrel). Again, risk-on. But since this is Friday and we could get news from the US trade delegation China this weekend, don’t expect today’s gains to hold. Bonds are mostly unchanged, strangely enough. The 5-year Treasury yield is hovering around 2.79%. The 10-year’s yield is 2.95%. 

April’s Employment Situation Report was published today, and is best characterized as “mixed.” Some metrics confirmed continued strength in the labor market. The unemployment rate fell below 4% for the first time in 17 years (the peak of the dotcom business cycle). The under-employment rate—which also accounts for discouraged workers and those accepting part-time work because they can’t find a full-time position—fell to 7.8% (nearly 17-year low). The average workweek held steady at 34.5 hours. Other parts of the report were a little less encouraging. Total net new payrolls for the month were 164,000 compared with 190,000 expected. However, I would point out that March payrolls, which were initially reported at a mere 103,000, were revised up to 135,000. While certainly not alarming, it is true that monthly payrolls have faded in recently months from the roughly 200,000 average in 2017. Next, the labor force participation rate edged lower, to 62.8%, and has really stagnated over the last two years. Finally—and this is what traders are obsessing about—wage inflation declined a bit. Whereas economists thought average hourly earnings were up 2.7% y/y in both March and April, it turns out wages grew 2.6% in both months. One-tenth of a percentage point doesn’t seem like a big deal, but remember investors are searching for any evidence of a trend in inflation. We sense that with a strong economy, tight labor market, strong corporate earnings, and a Federal Reserve in tightening mode, we should be seeing higher inflation readings. But the fact is, we aren’t seeing a clear trend yet. 

On Wednesday, the Federal Reserve wrapped up its monthly policy meeting and declined to raise short-term interest rates. For now. But officials made it clear that inflation is rising and more rate hikes are coming. The Fed is walking a tightrope between the necessity of normalizing interest rates and yet keeping the economy humming along. Accordingly, the Fed’s statement noted inflation is now close to its 2% target but is not expected to move significantly higher in the long term. So the Fed’s pace of rate hikes isn’t likely to accelerate. Treasury yields didn’t move much in the aftermath of the announcement. Most economists believe the Fed will raise rates in June. 

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