Why the Latest U.S. Employment Data Should Put an End to Speculation About Imminent U.S. Rate Increases

Over the past several weeks investors had been increasing their bets that the U.S. Federal Reserve would raise its policy rate in the near future, with the odds of a Fed rate hike in July peaking at about 58% last week.

This speculation was fueled by increasingly hawkish comments from several Fed members who warned that the improving U.S. economy would soon be ready for another round of monetary-policy tightening.

I had been sceptical about whether the Fed would actually follow through on its warnings because we have seen many recent examples of Fed talk not translating into action. And I don’t think it was a coincidence that the Fed’s rate-hike warnings grew louder at a time when the bond-futures market was pricing in odds of no Fed rate increases until early 2017.

Over the past several years the Fed has repeatedly used hawkish rhetoric to keep investors from becoming complacent whenever the lower-for-longer view started to really sink in. For my money, this latest rate-rise talk was just the most recent example of the Fed using the power of its words to keep moral hazard risks at bay.

That said, we’ll never know for sure because the latest U.S. employment report, released last Friday, was so bad that investors quickly reversed course and lowered the odds of a Fed rate hike in July all the way back down to 31% in less than a day.

Here are the highlights from the latest U.S. employment report, which was about as close to a stinker all round as we have seen in a long time:

• The U.S. economy added only 38,000 new jobs last month, dramatically less than the 160,000 new jobs that the consensus had been expecting, and well below the 125,000 or so new jobs that the U.S. economy needs just to keep pace with the natural growth of its labour force. This marks the fourth straight month where net U.S. job creation has fallen, effectively eliminating the U.S. labour market’s hard-won momentum. (The initial estimates for new-job creation from the prior two months were also revised downwards by 59,000 jobs.)
• Full-time employment shrunk by 59,000 jobs in May, and that’s on top of the 316,000 full-time jobs that were lost in April. The consensus had been expecting a bounce back in full-time positions after April’s drubbing, but that bounce did not materialize. Meanwhile, the number of Americans working part-time for economic reasons, meaning that they want full-time work but can’t find it, surged up by another 468,000 workers in May.
• Goods-producing employment fell again last month, by another 36,000 jobs, marking the fourth month in a row that employment in this vital sector has shrunk. Goods-producing jobs tend to be higher paying, and they also fuel job creation in other sectors, so this trend does not bode well for the overall health of the U.S. labour market.
• Economist David Rosenberg noted that employment in temporary services shrunk by 21,000 jobs in May, and is now down in four of the past five months, falling by a total of 64,000 jobs over that period. He cautions that this type of weakness in temporary-job creation has “occurred prior to economic recessions in the past, without exception”, and this is from an economist who has been more bullish than most about the U.S. economy’s prospects for some time.
• The unemployment rate fell from 5.0% to 4.7%, but as we have seen so many times since the start of the Great Recession, this reduction was caused by Americans withdrawing from the labour force, which means that they are no longer counted among the unemployed. In May, 458,000 able-bodied workers gave up looking for work, and that is in addition to the 362,000 workers who withdrew themselves in April. As a result, the participation rate fell from 62.8% to 62.6%, marking a six-month low.

Against this backdrop, it’s very hard to imagine the Fed raising its policy rate in the near future. The data in the latest report are not one-offs that can be dismissed as anomalies. Rather, they confirm the continuation, and intensification, of a slowdown in U.S. employment momentum.

To be clear, I don’t expect the Fed to completely capitulate on its rate-hike speculation when it meets next Wednesday. In fact, it may well continue to hint at the possibility of near-term rate rises, but only in the hopes that this talk will help keep lower-for-longer speculation at bay, and not as a serious indication that it will tighten monetary policy now that U.S. economic momentum is so dramatically waning.

Five-year Government of Canada (GoC) bond yields plunged by eighteen basis points last week, closing at 0.61% on Friday. Five-year fixed-rate mortgages are available in the 2.39% to 2.59% range, depending on the terms and conditions that are important to you, and five-year fixed-rate pre-approvals are offered at around 2.69%.

Five-year variable-rate mortgages are available in the prime minus 0.30% to prime minus 0.40% range, which translates into rates of 2.30% to 2.40% using today’s prime rate of 2.70%.

The Bottom Line: The latest U.S. employment report should end any further speculation about near-term Fed rate hikes. By association, this report also reduces the risk of a short-term run up in our GoC bond yields, which would have been expected to rise in sympathy with their U.S. equivalents if a Fed raise had appeared increasingly likely – and that means that both our fixed and variable mortgage rates should remain at or near today’s low levels for the foreseeable future.