Stock markets rallied in a holiday-shortened week to fall just short of new all-time highs. Fresh labor data from the May jobs report and weekly unemployment claims report provided positive figures from the economic recovery, although there is a clear dislocation between supply and demand. The “good but not great” reporting is a potential Goldilocks environment that allows the Federal Reserve to continue accommodative monetary policy, even as the economy roars back to life.
On Friday, the U.S. Bureau of Labor Statistics reported the economy added 559,000 jobs in May and the unemployment rate declined by 0.3% to 5.8%. Like last month, the headline jobs number in the May employment report was solidly positive, but still fell below consensus expectations. On Thursday, the Labor Department reported that initial jobless claims fell below 400,000 (385,000) for the first time since the early days of the COVID-19 pandemic. The last time that jobless claims were lower was the week of March 14, 2020 (256,000), before the number spiked to nearly 3 million the following week.
In May, the leisure and hospitality industry gained 292,000 jobs. During the depths of the pandemic in March and April of 2020, leisure and hospitality lost 8.2 million jobs. That level has been cut to 2.54 million, adding back almost 70% of the jobs lost since February of 2020. Additionally, total employment is still 7.6 million jobs below pre-pandemic levels, suggesting there is plenty of slack in the labor market to be tightened.
There is a clear-cut disparity between demand for labor and supply of workers, as there are 8.1 million job openings and 9.3 million unemployed workers. The speed of the recovery and reopening cycle mixed with federal stimulus has created a surge in demand for goods and services that is outpacing the desire and/or ability for people to return to work. Contributing factors include lack of childcare, COVID-19 caution and skill mismatches, but the leading theory, especially in political circles, is ongoing enhanced unemployment benefits.
Unemployed workers have been eligible to receive $300 per week in federal unemployment benefits in addition to state unemployment benefits as a part of coronavirus pandemic relief. The federal unemployment benefits were scheduled to run through September as provided in the American Rescue Plan. However, after the April jobs report showed a meager gain of 266,000 jobs in the middle of a ripping recovery, Republican governors started to act. As of now, 25 Republican governors have announced that they would stop the $300-per-week federal benefits before the program lapses in September. The 25 states declining federal funds have announced different end dates for the program. Benefits expire June 12th in Alaska, Iowa, Mississippi, and Missouri, while the other 21 states fall off through July 10th. Unemployed workers may still be eligible for regular state unemployment benefits, which vary from state to state.
Labor is maybe the preeminent force in our economy, especially one driven by consumption (approximately 70% of the U.S. economy). I think that is a good enough reason to cover jobs reports. But there is another important reason that also impacts the stock market – the reaction by the Federal Reserve.
Early into the pandemic recovery, the Fed made a clear policy shift to allow inflation to run hotter than their 2% target to focus on their full employment mandate. We fully supported the move because the Fed has continually been too quick on the trigger and undershot their inflation target (see interest rate hikes and the subsequent correction during 2018). Their current policy provides additional flexibility to keep accommodative programs (e.g., zero interest rate policy and quantitative easing) in place to support the recovery.
Their full employment mandate has also been broadened beyond the statutory unemployment rate. I’m still not exactly sure what changed, but maximum employment is now defined as a broad-based and inclusive goal. Fed policy decisions will be informed by “assessments of the shortfalls of employment from its maximum level” rather than previously “deviations from its maximum level”. We anticipate the Fed will pursue lower unemployment for longer than prior cycles. This also suggests that higher inflation (i.e., potentially in excess of 3%), not maximum employment, will be the cause of eventual policy adjustments.
The last two months of jobs reports puts absolutely no pressure on Fed officials to tighten monetary policy. In fact, it supports current accommodative policy. There has been talk of curtailing quantitative easing after recent inflation data, but slack in the labor market has provided some protective cover. It’s no coincidence that the stock market has had solidly positive days on the day of jobs report releases. A gradual recovery in employment is generally viewed by market participants as a Goldilocks scenario.
On Wednesday, the Fed did announce plans to begin gradually selling off their portfolio of corporate debt purchased through an emergency lending facility launched last year. There was approximately $13.7 billion outstanding in the Fed’s Secondary Market Corporate Credit Facility in a range of corporate bond and ETF holdings. The Fed spokesman made it clear that the corporate bond portfolio winddown has nothing to do with monetary policy. It is a very small portion of a now $8 trillion balance sheet, but it renewed concerns over the Fed scaling back their $120 billion in monthly asset purchases in coming months.
The Fed will try to avoid spooking markets like it did in May 2013 when then-Fed Chairman Ben Bernanke triggered the “taper tantrum” in his testimony regarding an upcoming reduction in bond purchases. The benchmark 10-year U.S. Treasury yield rose from 1.66% to 3.04% from the start of May 2013 to the end of that year, which caused some issues in the bond market and foreign currency markets. However, the S&P 500 soared 21.4% over that same time. So, the Fed and investors have precedent for tapering purchases, and it doesn’t spell doom for equity markets.
Have a great Sunday!
Timothy W. Ellis, Jr., CPA/PFS, CFP®
Senior Investment Strategist, Wealth Strategist