Last week’s better than expected US jobs report continued to fuel further optimism in the US economic recovery, driving both equity markets and bond yields higher. With the Fed equally focused on its dual mandate, the higher jobs numbers once again put the spotlight on whether inflationary pressures will force the Fed to raise interest rates quicker than expected.

As confidence in the economic recovery continues to grow, earnings expectations and inflationary concerns have also picked up. While equity investors continue to enjoy the market rally, bond investors are faced with a rising yield environment. Since the start of the year, the US 10-year Treasury yield climbed over 75 basis points and is currently trading around the 1.7% level. With short-term rates anchored by the Federal Reserve monetary policy and longer term rates rising, the US yield curve has continued to steepen. Implicitly, break-even rates, known as proxies for inflation expectation have also ticked higher and exceeded the 2.2% level. This significant move represents the rapid pace at which the US economic recovery is taking shape.

Even so, despite that inflation expectations are picking up, the US Federal Reserve remains equally focused on the second part of its dual mandate, that of maximum employment. Under the new monetary policy framework, the Fed is expected to tolerate any transitory rise in inflationary pressures until ‘substantial progress’ can be seen towards achieving its goals, including a broad and more inclusive maximum employment goal.

Employment numbers released last week showed solid signs of improvement, on the back of a faster vaccination program and fewer economic restrictions. The US employment sector added a seasonally adjusted 916,000 jobs during the month of March, marking the best increase since last August. This number came in better than the expected 647,000 job gains.

Most importantly, the stronger than expected employment gains marked a pickup in hiring across the board including the hardest hit sectors of the pandemic. The leisure and hospitality industry contributed 30% of the monthly additional employment, followed by the public and private education, and the construction industries. However, hiring across the professional and business services as well as manufacturing also reached above pre-crisis levels and signal positive underlying hiring momentum.

On the unemployment side, the gains over the month lowered the US unemployment rate to the 6% level, in line with expectations. Despite that the 6% unemployment rate marks strong employment gains compared to the 14.8% level seen last April, one should note that unemployment rate still stands twice as high compared to the pre-pandemic level of 3.5%. In numbers, the unemployment rate still represents a job deficit of 8.4 million when compared to February 2020. In fact, despite the pick up across the hardest hit sectors, estimates still show that leisure and hospitality together with education and health, account for half of the current job deficits in the US economy.

Similarly, jobless claims applications continued to trend lower, despite that the weekly initial jobless claims applications rose above market expectations. Nonetheless, the US still records more than 18 million Americans which continuously seek jobless benefits. This labour market slack is expected to continue to weigh down on wage inflation.

Further insight is achieved by looking at the level of participation, which accounts for the percentage of people within the working age population who are employed or actively seeking employment. In last week’s jobs update, the labour force participation rate inched to a three-month high of 61.5%. However, this rate still stands below the pre-pandemic level of more than 63% and signals that Americans still remain discouraged to join the labour force. When considering the decline in the participation levels, economist assess that the real unemployment figure is closer to the 8.5% and 9% levels.

Therefore, while headline employment numbers are heading in the right direction, the underlying data shows that labour market slack remains. As to inflationary pressures, while the rise in bond market yields acts a clear indicator for the expected rise in interest rates, actual inflationary pressures are unlikely to materialise unless labour market conditions tighten sharply and push wage inflation higher. Nevertheless, given the extent of fiscal support and pent-up savings, the timing of this turnaround remains highly uncertain, and investors in risky assets must stay cautious if yields continue to accelerate.


This article was written by Rachel Meilak, CFA, Equity Analyst at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd which is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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