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Expectations about the path of US growth have declined steadily over the past few months. Consensus forecasts have gone from very strong growth, to serious doubts over where growth is headed, to recession fears. On the other hand, the Federal Reserve (Fed) has been unwavering in its views and rhetoric about policy normalization, creating a toxic combination for markets. At Invesco Fixed Income, our own expectations of stable-to-weak growth and tightening financial conditions had led us to a short credit, long duration view late last year.
However, strong employment data released on Jan. 4 will likely offset much of the market’s fears of sharply declining growth, in our view, and recent comments by Fed Chair Jerome Powell seem to have opened the door for the Fed to relent on its current trajectory. Due to these developments, our near-term growth expectations have improved, and we expect slightly easier financial conditions in the first half of 2019, which will likely support risk assets.
Strong December employment data boosted growth outlooks
December payroll data surprised significantly to the upside. Total nonfarm payrolls increased by 312,000 jobs in December versus a consensus of 180,000, bringing the three-month trend to around 254,000 and the six-month trend to around 222,000 jobs.1
Longer-term trends in payrolls are typically good predictors of gross domestic product (GDP) growth. The Jan. 4 employment report validates our view that there is little evidence of a looming recession, and points to solid growth in the first half of 2019. While we want to avoid putting too much weight on one data point, this payroll report adds to the already positive consumer picture (a solid holiday season and December car sales, strong consumer balance sheets and growing wages). Uncertainties remain elevated for the second half of the year, and we continue to expect a slowdown in growth after the impact of stimulative fiscal policy wanes and the Fed continues to normalize policy.
Figure 1: Monthly payrolls surged in December
Source: US Bureau of Labor Statistics, Jan. 4, 2018.
December unemployment increased, but this was due to an increase in the labor force participation rate, likely due to stronger employment conditions. Average hourly wages also surprised to the upside, increasing by 0.4% versus an expected 0.3%.1 While these data have been volatile in the past, they are in line with our view that wage growth is gradually accelerating and will likely attract the attention of policy makers later this year.
Implications for the Fed
Powell suggested in his Jan. 4 remarks that the Fed may take a more cautious approach going forward. In our view, Powell’s rhetoric did not shift as much as headlines suggested, but he did appear to adopt a more dovish stance. While he remained upbeat on the economy, he reiterated the Fed’s cautious stance going forward. Namely, he said that the Fed would be patient in raising interest rates further due to lackluster inflation data and that it would be flexible if conditions warrant. He also stated that policy flexibility applies to the Fed’s balance sheet; while Powell suggested that recent market volatility is not due to the shrinking balance sheet, and stated that the reduction will continue for now, he acknowledged that the process can be altered, if need be.
Markets reacted to the developments with a risk-on tone in credit and equities, and the US Treasury yield curve flattened. The US dollar strengthened in response to the payroll data, only to trade weaker following Powell’s remarks. Overall, market reactions reflected expectations of a more cautious Fed going forward. Without significant inflationary pressures, we believe the Fed has the flexibility to be cautious.
Invesco Fixed Income outlook
Given our outlook for benign core consumer price inflation in the near term, and little evidence of a potential breakout in inflation, we expect the Fed to maintain its cautionary tone through the first quarter of 2019, with no rate hike in March. A Fed “pause” against a solid growth backdrop should be supportive of risky assets, in our view. However, we expect volatility to continue as growth data moderates to lower levels.
A more cautious Fed (and easier financial conditions) could potentially lead to a prolonged growth story and less chance of recession in the near term. However, this dynamic could also raise the risk of a potentially more aggressive Fed later on in the year when wages are rising.
1 Source: US Bureau of Labor Statistics, as of Jan. 4, 2019
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Duration is a measure of the sensitivity of the price (the value of principal) of a fixed income investment to a change in interest rates. Duration is expressed as a number of years.
Gross domestic product is a broad indicator of a region’s economic activity, measuring the monetary value of all the finished goods and services produced in that region over a specified period of time.
The yield curve plots interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates to project future interest rate changes and economic activity. A flat yield curve is one in which there is little difference in the yields for short-term and long-term bonds of the same credit quality. In a normal yield curve, longer-term bonds have a higher yield.
Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
Noelle Corum, CFA
Associate Portfolio Manager
Invesco Fixed Income
Noelle Corum joined Invesco Fixed Income in August of 2010 and is involved in derivatives, FX and rates trading, macro view implementation and asset allocation.
Ms. Corum began her investment professional career at Invesco following her undergraduate studies.
She earned a BS degree in business administration, with a concentration in financial analysis, from Saint Louis University, where she minored in mathematics and earned a certificate in service leadership.