By John Beuerlein, chief economist, Pohlad Companies
The stronger than expected May employment report that was released on June 1 showed non-farm payrolls increased 223,000 during May. This reinforces the likelihood that the Fed will increase the Federal Funds rate at their June 12-13 meeting from 1.75 percent to 2.00 percent. The markets continue to expect one more interest rate hike in the second half of the year – consistent with previous Fed guidance. As mentioned in previous commentaries, if inflationary pressures develop more quickly than they currently expect, however, there is a possibility that the Fed will have two rate hikes in the second half of 2018, rather than one.
Based on Friday’s employment report, the labor market has been gradually strengthening since last September when hurricanes disrupted the labor markets in several east coast states. Since September 2017, the 12-month average employment has moved from 168,000 per month to 198,000 per month.
Over that same time period, the unemployment rate has fallen from 4.2 percent to 3.8 percent. The 3.8 percent rate is the lowest reading since April 2000. You must go back to early 1970 to find a lower unemployment rate.
Despite this ongoing strength in labor statistics, however, average hourly earnings of workers are still only growing at 2.7 percent yr/yr. Wages are improving, but the rate of growth remains tepid. Wage pressures are still sufficiently moderate to prevent Fed officials from worrying that they are at risk of falling behind the inflation curve.
Looking at interest rates, continue to keep an eye on the yield curve – specifically the difference between 10-year Treasury yields and 2-year Treasury yields. Over the past month the difference has ranged between 42 basis points and 54 basis points.
If short rates (2-year Treasury yields) continue to advance and move above the 10-year Treasury yields, we will have a situation known as an inverted yield curve. Historically, an inverted yield curve has preceded the onset of a recession by 12 – 18 months over the past 60 years. The Fed is very aware of this phenomenon. It will be interesting to see how aggressive the Fed will be for the remainder of the year in pushing short rates higher and causing the 10-year/2-year spread to tighten further.
Complicating the interest rate picture further are the on-again/off-again trade talks. Until there is clearer resolution to this situation, expect continued uncertainty and volatility in the expected trend of interest rates.
Although the US economic landscape is holding firm, there are signs developing that a transition to slower growth may be developing as we move through 2018 and lose the positive impact of the Tax Cut & Jobs Act passed last December. Rising yields, a flattening yield curve, slowing money supply growth, and increased market volatility all suggest that the credit market cycle is in its later stages and the economic cycle is maturing.