Ameriprise Financial : The May Jobs Report Catches Everyone by Surprise

The May jobs report took everyone by surprise and quickly silenced any talk of a possible rate hike at the Fed's meeting next week. A June rate hike was a longshot even before the jobs report, but the stunning weakness of the report removed any chance of that happening, and simultaneously cut the odds of a July hike to just 27 percent, half what they were the day before the report. In May the economy created just 38,000 new jobs, well below the consensus expectation of 160,000, and the weakest in six years. Even allowing for almost 40,000 striking Verizon workers, the number of new jobs was still less than half what was expected. In addition, the total from the previous two months was reduced by a whopping 59,000.

What made the May jobs report so shocking was how much of an apparent outlier it was. The labor market had created an average of 178,000 new jobs this year through April. It would be easy to dismiss the report as an aberration. And it may turn out to be just that. One month does not a make a trend. And other recent economic data has shown improvement from the soft first quarter. However, somewhat worrisome is the fact that the monthly totals have now exhibited a decelerating trend. In February 233,000 new jobs were created. In March that total fell to 186,000 and to 123,000 in April, only to be followed by the May clunker.

Some slowdown is to be expected given the already sizeable fall in unemployment and the slow growth environment. But this latest report seems to have come from left field. What it does do is place outsized importance on the June report. A strong rebound and the May report will be overlooked. However, another soft result and the Fed's intentions of raising rates more than once this year, if at all, will become increasingly suspect, and expectations for second half growth of better than 2.0 percent will need to be revisited as well.

The Financial Sector Takes a Hit

Stocks were flat on the week, including only a fractional loss on Friday following the jobs report. However, financial stocks slumped, dropping 1.4 percent on Friday, led by banks, which got hammered and dropped 2.3 percent. The banks had been rallying on the expectation that higher interest rates would result in improved profitability. On Friday they ran into a brick wall. The jobs report wasn't the only challenging news that banks received last week. They also learned that the Federal Reserve is moving toward proposing a higher capital ratio for eight of the largest U.S. banks, to be effective in 2018. In effect, the Fed is allowing banks to remain big, but making them pay for that choice because of their size and risk to the financial system. Whether it is worth it is up to the banks.

The challenges facing banks are numerous, but also well known and presumably reflected in their valuations. Increased regulatory oversight, slumping trading revenue, and overall sluggish economic growth have made their operating environment difficult. But the prospect of higher interest rates was a potential offset, and has recently been a catalyst for higher share prices. For now, the hope of higher interest rates has been at best delayed and at worst derailed. According to the Wall Street Journal, bank stocks have recently been twice as volatile as the overall market and 60 percent more volatile than ten years ago. They have as much as any group riding on a rebound in the June employment report.

Bonds Rallied as Yields Fell

Where there are losers there are also winners. Not everyone was grumbling about the jobs report. Bonds rallied as yields fell. The two-year note saw a yield drop of 11 basis points to 0.78 percent on Friday, and the ten-year yield fell from 1.80 to 1.70 percent. Rate sensitive utility stocks rose 1.7 percent on Friday, as did consumer staples and telecom. But materials also climbed as the dollar weakened sharply on the lowered expectations for interest rate hikes following the jobs report. The DXY dollar index lost 1.6 percent on Friday, retracing in one day half its rise from early May. Emerging market equities welcomed the weaker dollar and rallied 0.5 percent on Friday.

The extent of the sluggish global growth environment came into stark relief as Fitch reported that the total amount of negative yielding sovereign debt crossed the $10 trillion level for the first time, and now spans fourteen countries. Certain corporate bonds are also now trading with negative yields, although the dollar amount is much smaller. That, however, will likely begin to grow as the European Central Bank begins buying corporate bonds this week as part of its basket of stimulus measures.

In the UK, the latest round of polls show the movement to exit the European Union is gathering steam and taking the lead from those leaning toward a stay vote. Recent equity price movement in Europe does not seem to indicate too much concern regarding a potential leave vote. Central bankers and politicians have weighed in, but equities have actually moved a little higher over the past month, betraying a certain complacency regarding the outcome. The vote is now just two and a half weeks away. Whether that sanguine outlook holds remains to be seen. The UK vote is one more reason why next week's Fed meeting will likely be uneventful.

Important Disclosures:
The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The U.S. Dollar Index (DXY) measures the dollar's value against a trade-weighted basket of six major currencies.
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