When people make more money, they spend more money. That's a good thing for an economy where consumer spending accounts for approximately 70% of real GDP.
What's good for the economy, though, isn't always good for the stock market, especially when the stock market starts thinking the stronger spending will stoke higher inflation and higher interest rates.
That was the rub of the January Employment Situation Report, which produced the strongest year-over-year growth in average hourly earnings (2.9%) since May 2009 and spooked the stock market into thinking the Federal Reserve might have to be more aggressive with rate hikes this year than previously thought.
In brief, an assumption came to pass that four rate hikes might be necessary instead of the median estimate of three rate hikes that was seen in the Federal Reserve's interest rate projections in December. That thought process pushed up market rates and it acted as an expedient for the first 10% correction in the S&P 500 in nearly two years.
Interest rates and the stock market have settled down some in the interim, yet they haven't necessarily felt settled.
The Employment Situation Report for February, however, should qualify as a settling influence.
The key takeaway from the report is that it resuscitated the Goldilocks narrative. Specifically, it was highlighted by robust job growth and a deceleration in the year-over-year change in average hourly earnings, which should help temper the angst about wage-based inflation pressures that were borne out of the January employment report.
The question now is, will the Treasury market settle down or will it ride a position of angst that wage-based inflation pressure is inevitable with the strong job growth and full employment? The 10-yr yield, which was unchanged at 2.87% in front of the report, has increased three basis points to 2.90% following the report.
The second question is, will the stock market be put off by the bump in rates or will it see through them as a sign of confidence in a strengthening economy that is good for earnings growth?
That answer may depend on the pace at which interest rates go up, yet there is no mistaking that the February employment report couldn't have been drawn up much better for the stock market.
The notable headlines from the Employment Situation Report are as follows:
- February nonfarm payrolls increased by 313,000 (Briefing.com consensus 210,000). Over the past three months, job gains have averaged 242,000 per month
- January nonfarm payrolls revised to 239,000 from 200,000
- December nonfarm payrolls revised to 175,000 from 160,000
- February private sector payrolls increased by 287,000 (Briefing.com consensus 195,000)
- January private sector payrolls revised to 238,000 from 196,000
- December private sector payrolls revised to 174,000 from 166,000
- February unemployment rate was 4.1% (Briefing.com consensus 4.0%) versus 4.1% in January
- Persons unemployed for 27 weeks or more accounted for 20.7% of the unemployed versus 21.5% in January
- The U6 unemployment rate, which accounts for unemployed and underemployed workers, was 8.2%, unchanged from January
- February average hourly earnings were up 0.2% (Briefing.com consensus 0.2%), rounding up from the specific 0.15% increase, after increasing 0.3% in January (rounding up from the specific 0.26% increase)
- Over the last 12 months, average hourly earnings have risen 2.6%, versus 2.8% for the 12 months ending in January
- The average workweek in February was 34.5 hours (Briefing.com consensus 34.4) versus an upwardly revised 34.4 hours (from 34.3) in January
- February manufacturing workweek was 41.0 hours versus 40.8 hours in January
- Factory overtime increased 0.1 hours to 3.6 hours
- The labor force participation rate was 63.0% in February, versus 62.7% in January
What It All Means
The Goldilocks view did wonders for the stock market in 2017 because it kept rate-hike fears at bay, paving the way for a continuation of the bull market.
With respect to the February employment report, it won't stop the Federal Reserve from raising the fed funds rate at the FOMC meeting later this month. In the same vein, it should keep the Federal Reserve wedded to its median estimate of three rate hikes this year.
A fourth rate hike isn't out of the question. The fed funds futures market is currently pricing in a 35.8% probability of a fourth rate hike in December (following expected rate hikes in March, June, and September), but it's going to take some scarier-looking inflation data most likely to tip that probability above 50.0%.
For now, then, the stock market has a basis to think the Federal Reserve will continue to walk a prudent path, raising rates gradually so as not to choke off economic growth prematurely while giving itself some more cushion to cut rates if, and when, it needs to in the future.
The gist is that the stock market will co-exist again with the thought that a gradual move up in rates need not be feared because it is a sign of confidence in the economic outlook.
The key word there is "gradual."
We have talked before how the stock market doesn't like it when rates move up quickly, because that gets interpreted as a sign that the Federal Reserve is behind the growth curve and will have to be more aggressive to catch up to it, most likely going too far in its attempt and committing a policy mistake that leads to a marked slowdown (if not a recession).
Fittingly, today marks the 9-year anniversary of the market bottom in 2009 that took root on the back of extraordinarily accommodative monetary policy. The Federal Reserve in recent years has turned less accommodative with its policy, yet its policy still can't be thought of as tight.
The stock market has come a long way from that bottom, and it moved up in the wake of the February employment report.
It did so because the stock market recognized the report provided good, not great, economic news -- and good news is what the stock market likes best because it doesn't feed great expectations of an overly-hawkish Federal Reserve.