Strong Employment Report May Accelerate Fed Rate Increases

|
Includes: DIA, QQQ, SPY
by: Kevin Wenck, CFA

Summary

July employment growth higher than expected at 255,000.

Consensus estimates were for an increase of 180,000 jobs.

Two strong employment reports in a row may change the Fed rate increase schedule.

Strong report continues strong consumer trends seen in Q2 GDP report.

Introduction

The Bureau of Labor Statistics released its July "Employment Situation Summary" this morning and employment growth was higher than expected. Consensus expectations had been for a gain of 180,000 jobs, but the July increase was 255,000 jobs. There was also an upward revision to the already strong June report of an additional 5,000 jobs added in that month. The very surprising weak May report also had another upward revision of 13,000 jobs, and so that month's report, which sparked a large financial markets reaction, was apparently just some sort of government statistics anomaly.

The strong July report may also possibly change consensus thinking about the schedule for future Federal Reserve interest rate increases. There will be one more employment report released between now and the next Fed meeting on September 20-21, and if that report is also strong, then there could be what would be a currently unanticipated rate increase at the September meeting.

The most recent employment report also provides further support for the strong consumer spending trends seen in the Q2 GDP report released last week. Although the overall GDP number reported in that report was a lower-than-expected 1.2 percent, as I described in an article last week, that report was affected by a very surprising reported increase in the price deflator to 2.2 percent for Q2 versus only 0.5 percent in Q1.

Additional details in the July employment report

Strong growth in higher-earning segments such as professional and business services (up 70,000), healthcare (up 43,000), and financial activities (up 18,000) also adds further support to the strong consumer spending trends seen in the Q2 GDP report. Stronger consumer trends are also apparently being noticed by employers in consumer-facing industries such as leisure and hospitality which increased 45,000 during July. The growth of government employment also continues to increase with a gain of 38,000 jobs in July (but I'm not sure that is good thing given the typical productivity of government related activities!).

Another interesting indicator of the current strength of the labor market is that for workers who are recently unemployed, they are apparently finding new jobs very quickly. That indicator is seen in the number of persons unemployed less than five weeks which decreased by 258,000. Trends for the "long-term unemployed" (defined as being jobless for 27 weeks or more) are still not improving, however, as that number was unchanged at around 2 million potential workers. That number is still also a fairly large 27 percent of the total number of unemployed workers. The Fed is probably closely watching trends in that cohort of the workforce and so unless trends start improving in that group, that could still be a reason for the Fed to not increase rates in September.

Other aggregate statistics were also little changed in July with the labor force participation rate being 62.8 percent, the employment/population ratio being 59.7 percent, and the unemployment rate being 4.9 percent. Workers employed part-time who are considered to be "involuntary part-time workers" are also not seeing improving conditions and were 5.9 million in July. Trends in workers "marginally attached" to the labor force category who are no longer included in the overall labor force (as they have not looked for a job in the latest month) are also not improving and were reported in July to be 2 million potential additional workers. That segment is divided into "discouraged workers" who would like to work but are not current looking for a job at almost 600,000 and then another 1.4 million who are not currently looking for work while attending school or taking care of family members.

One additional detail that is worth noting given the already mentioned stronger consumer behavior currently being seen is that July's average hourly earnings rose 2.6 percent on an annual basis. That is also the same annualized increase seen in June and so stronger consumer spending trends may have a solid base for continuing.

Investment implications

If you are a bond investor today, you are not happy about the recent report as the 10-year Treasury yield has increased eight basis points today to 1.59 percent. Looking at technical trends for the 10-year, any additional upward moves above 1.61 could result in an additional move to the 1.70 to 1.75 area.

Equity investors may also have mixed feelings about the current report as the main driver of equity prices for years at this point is that the Fed's artificially created liquidity, which is not being demanded by most sectors of the U.S. economy as they are mature companies with positive cash flows, has been the main driver in supporting equity prices as the excess liquidity has then flowed into financial markets.

I have my own point of view, however, which is that gradually increasing interest rates may actually be a healthy factor in creating more stable economic growth. I think somewhat higher rates could curb more speculative economic and financial market activities that I view as actually being damaging to a healthy economic environment. Heavily indebted companies obviously wouldn't benefit from an increasing rate cycle, but their healthier competitors would benefit.

Although overall equity markets would be somewhat dampened by future rate increases, the two strong employment reports in a row have already been great for financial stocks and are also providing some support for consumer-oriented stocks. The very low valuations for financial stocks could also result in pretty strong additional gains from current levels of between 15 and 20 percent over the next three to six months.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.