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Will improved hiring bring consumption back up to speed again?

Phalguni Soni

Why April 2014 saw the best payroll numbers since January 2012 (Part 5 of 10)

(Continued from Part 4)

Hiring and consumption

The Bureau of Labor Statistics released the Employment Situation report for April on Friday, May 2. One of the most keenly watched monthly labor indicators, the report estimated that the U.S. economy added about 288,000 jobs in the non-farm sector in April—the highest additions since January 2012, when the economy added 360,000 jobs. The unemployment rate too dropped sharply, to 6.3% in April from 6.7% the previous month, the lowest level since Lehman’s bankruptcy in September 2008.

Why financial markets reacted contrary to expectations after the BLS jobs report

Financial markets should have reacted positively to the good news, right? Well, the market’s reaction to the report was contrary to what markets had expected. The S&P 500 Index (^GSPC) fell 0.1% to end at 18,881.14 on May 2. Thirty-Year Treasury yields declined by 4 basis points to end at 3.37%. The spread between five-year and 30-year Treasuries, at 170 basis points (or bps), narrowed to the lowest since September 29, 2009, when they were recorded at 169 bps. The iShares 20+ Year Treasury Bond ETF (TLT) rose 0.6% to $112.71 on May 2.

A better-than-expected jobs report signals that the economy is improving, and this would usually lead to an increase in stock market prices, positively impacting broad-based indices like the S&P 500 Index (VOO). An improving economy would also imply increasing interest rates and declining bond prices. So why did stock prices decline and bond prices rise after the jobs release? There were two reasons for the reaction.

  • The increase in stock prices was dampened by rising tensions in Ukraine and their implications for energy prices. Russia is a major energy supplier, and an embargo on Russian supplies (as the EU has threatened) would lead to increasing energy prices, affecting the overall economy. U.S. bond prices, especially Treasuries, increased since they’re perceived as safe-haven assets and investors typically flock to these assets in times of turmoil.
  • The ADP National Employment Report, which released on Wednesday, April 30, also beat consensus expectations, reporting that 220,000 jobs were added in the private non-farm sector in April. The financial markets like the S&P 500 Index (VOO) and the Dow Jones Industrial Average (DIA) had already had a heads-up on the BLS number for payroll additions because of the ADP-NER, which released two days earlier. Although the ADP-NER covers only the private sector, ADP (ADP) estimates a 96% correlation between its private non-farm payroll addition estimates and those issued by the BLS.

Implications of the BLS payrolls reports

The most obvious implication of the report is consumption growth. Higher payroll numbers would imply higher total disposable income among the workforce. More income translates to higher spending and probably higher personal debt levels as well. These factors would increase demand in the economy, and if sustained, inflation as well. This is good news for the Fed, as inflation has been the one variable that’s stubbornly stayed at ~1% levels over the past year.

As consumption contributes over two-thirds of the economy, higher consumer spending will mean higher GDP, all else equal. This in turn would imply there’s no further need for monetary stimulus in the economy and the Fed would raise the base rate, signaling the start of monetary tightening. Higher base rates would probably increase rates across other maturities as well and mean lower bond prices. This would lower the prices of long-only ETFs like the Core Total U.S. Bond Market ETF (AGG).

Higher consumption will also impact companies in the discretionary consumer space. A good way to invest in these companies is through ETFs like the State Street SPDR S&P Retail ETF (XRT) that tracks the S&P Retail Select Industry Index (an equal-weighted market cap index), composed of the retail sub-industry portion of the S&P TMI.

In the next part of this series, we’ll discuss a weekly labor release—initial jobless claims. Please read on.

Continue to Part 6

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