A holiday shortened week with a large amount of economic reports was punctuated with two notable misses on Friday, signaling some distinct FOMC implications. U.S. job creation for May of 38,000 was the lowest print since 2010 and badly missed expectations for greater than 100,000. This was a 5 standard deviation miss, the largest miss in 2.5 years, and the weakest headline number since the start of the current all-time record streak of job creation (68 consecutive months). The unemployment rate did fall from 5% to 4.7%, largely due to a further drop in labor force participation to 62.6%. A weak ISM non-manufacturing number on Friday also fed overall sentiment that a June rate hike, which in recent weeks had become more of a remote possibility, is almost certainly off the table. Futures markets sent the likelihood of a June rate hike down from 28% to only 4% during the course of the week. July and September odds also fell to 27% and 38% respectively, interestingly low given the Fed’s desire to work in two rate hikes in 2016. If the Fed does not raise rates in June, but proceeds at a later date, it would be the longest period in 40 years between the first and second hike. Importantly, not all economic reports were weak, particularly on the consumer side of the equation. Personal spending (1% m/m) soared in April, strong May wage growth (2.5% y/y), and continued strength in home prices all flashed green. Figures for the Fed’s preferred measure of inflation, core PCE, came in tame at a 1.6% annual clip.
Treasury yields and the U.S. dollar both fell sharply in response to the weak economic reports and ensuing rate hike implications. Ten year yields fell sharply back to 1.70%, close to the low point of 2016, while the two year yield reversed much of its gains over the past few weeks. Credit spreads remained sanguine on the disappointing economic news with investment grade and high yield spreads at approximately 155 and 605 respectively, down meaningfully from nearly 220 and 890 earlier in the year. It is interesting to point out that the VIX (volatility) declined on Friday and two month realized volatility has trended lower. Also of note is that breadth measures and small cap stocks have performed relatively well over the past few weeks.
