Continued weak economic data, including waning inflation and slower growth in housing, had little impact on the broader domestic equity indices last week. Although the Nasdaq (-0.9%) continued to nurse a hangover from the prior week’s “tech wreck”, the S&P 500 managed to move higher by 0.1% and the Dow Jones Industrial Average rose 0.5% to another record high. International stocks were largely on offer, with declines ranging from -0.8% in developed markets to -1.4% in emerging markets. Yields on fixed income instruments moved lower, likely in response to the disappointing economic data and the Fed’s plan to continue on their path towards monetary policy “normalization” (see below). The commodity complex, including precious metals, closed the week in the red and the US Dollar declined by 0.1%, though it us up 0.2% for the month.
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Doubting Ms. Yellen – As widely anticipated, the Federal Open Market Committee (aka the “FOMC” or “Fed”) increased interest rates last week by 0.25% to 1.25%. They plan to increase rates again in the second half of the year, but Mr. Market is doubting their resolve. Three FOMC meetings remain on the 2017 schedule, yet Bloomberg data indicates the probability of a rate hike is approximately 16% for each of the next two meetings and only 35% for the final meeting of the year. Indeed, for all of 2018 the market is placing only a 40% chance of an additional rate hike. Supporting the probability-based data’s view on hikes, the two-year Treasury’s yield of less than 1.4% implies there will only be one additional hike for the next 24 months. The market-based view has become deeply separated from the Fed’s forecast to raise rates one more time in 2017 and an additional three hikes in 2018, which if it comes to pass will push the Fed’s Target rate up to 2.25%. Indeed, the market is assigning a 0% probability of that outcome and with the 10-year Treasury yielding 2.15%, bond holders don’t believe the forecast either. Absent a material increase in economic activity (of which we see little current supportive data), if the Fed continues on their target rate path the bull market will not die of old age, but will be murdered by the Fed (which is how these things usually go anyways).
Immigration and Unemployment: A curious trend is emerging in the labor market. The unemployment rate amongst 20-24 year olds peaked at around 17% following the Financial Crisis, whereas unemployment “only” rose to 8.5% for workers who were 25 years and older. Although the unemployment rate for both age cohorts has declined steadily over the last seven years, there has been a marked increase in hiring younger workers. The expanded job gains amongst this younger cohort has pushed the unemployment rate down to approximately 7% – a level that is lower than before the Financial Crisis. Gainful employment of some of the youngest workers in our society is good for the economy, but why the sudden hiring binge?
FTN Financial suggests the increased hiring of younger workers is related to the Trump Administration’s border policies. While there is no official data collected on illegal immigration, anecdotal evidence from arrests (down 65% since the election) and charities working with immigrants suggest undocumented immigration has plummeted since the election. With the pool of undocumented workers drying up, employers are likely turning to younger workers to fill low-skill positions, driving down the unemployment rate. For example, McDonald’s recently announced they would hire 250,000 employees via a Snapchat campaign, a hiring strategy clearly targeting younger workers. Because the unemployment rate is a key input into the Fed’s monetary policy (they are devotees of the Phillips curve, an empirical model indicating that inflation is inversely related to the unemployment rate), Trump’s border policy could hasten additional tightening by the Fed. As detailed above, that may not be what the economy needs right now.