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Weak Payroll Report Dashes Rate Hike Expectations

| June 06, 2016
MPCA Weekly Market Update

Markets made little headway last week, as a promising start was wiped out on Friday due to a stunningly weak employment report. The S&P 500 ended the month of May with a 1.79% return, which was the second strongest month so far in 2016. The S&P 500 has now been positive for three consecutive months and is up 3.71% for the year. Near-term market returns continue to be held hostage by the perceived effect of economic data on the odds of a Fed rate hike. According to Bloomberg, at the close of the prior week the odds of a Fed rate hike were at 30% in June and there was a 54% chance in the July meeting.  At the close on Friday, Bloomberg now shows a 2% chance of a June hike and a 26% chance of a July hike.

As the odds of higher interest rates fall, so do returns in the banking sector. Banks and insurance company earnings are significantly impacted by the direction of interest rates. Specifically, rising interest rates count as bullish for the financial sector, affecting both lending profitability and contributing meaningfully to money market spreads. Banks and insurance companies are the guilty parties in the continuing underperformance of the greater financial sector, and rising rates would go a long way toward changing that narrative.

The S&P 500 Banking Index had a -2.25% return on Friday and a -1.63% return for the week. On the flip side, sectors that are interest-rate sensitive (think utilities and consumer staples) continued to outperform the broader market. The S&P 500 Utilities Index had a 2.56% return for the week while the S&P 500 Consumer Staples Index had a 1.09% return. For the week ahead, data on mortgage applications, jobless claims, and consumer sentiment are potential events that could impact financial markets.

Speaking of events that could move the markets, Federal Reserve Chairwoman Janet Yellen addressed the World Affairs Council in Philadelphia earlier today. The short version: do not overreact to the jobs report. She held firm on the need to raise rates, but refrained from attaching a time frame to the rate hike schedule. CNBC reports that Yellen also said the overall labor market is quite positive. Although the recent slowdown in jobs bears "close watching," she said, wage growth may "finally be picking up." Markets may regard her comments with skepticism. After all, although the unemployment rate dropped to 4.7%, the lowest level in this cycle, it fell mostly because participants dropped out of the labor force, not because more workers found jobs. Additionally, the Fed's Beige Book, which sets the economic stage for the FOMC ahead of its meeting later this month, describes growth across the US as modest. A few districts reported moderate growth, while two districts — Chicago and Kansas City — reported that it had slowed.

Finally, in what is becoming a repetitious headline, the Organization for Economic Cooperation and Development (“OECD”) lowered its forecast for global growth in 2016 to 3.0% from its previous 3.3% outlook. Have no fear, though – the OECD’s antidote to what ails the world economy remains the same. Chief Economist Catherine Mann called for urgent government action to stimulate faltering growth in the world's largest economies.