INSIGHTS

On March 16, 2015

AAM Viewpoints - U.S. Economic Footing Remains Sturdy

Last month, we noted that volatility would likely persist in markets, and we didn’t have to look farther than the 10-year U.S. Treasury bond to find it: after hitting a 2015 low on January 30, the yield on the 10-year rose more than 33 bps (basis points) by late February.¹ This more than one-standard-deviation move is on top of a 53 bps tightening the prior month. Indeed, volatility has arrived!

The most likely culprit kicking off the jump in yields was the stronger-than-expected U.S. employment report. Payrolls rose by 257,000² which beat our expectations (and the market’s) of about 232,000. While the payroll print is below the six-month average increase of 282,000, we see anything north of 200,000 as very strong and expect the pace of job additions to moderate as the year progresses.

The unemployment rate from the same report also struck us as a positive, despite increasing 0.1% to 5.7%. The unemployment rate increased because more people outside of the labor force are now seeking jobs, which pushed the labor force participation rate (LFPR) up to 62.9%. To us, this signifies that cyclically disenfranchised workers are finding job prospects strong enough to seek them out. However, we see the longer term demographic trends dominating the LFPR and believe it will head downward once any cyclical factors are worked off in the near term.

We consider industrial production to be a strong indicator of the health of the U.S. economy and some data concerned us that it may be weakening substantially. Plus, industrial production fell by 0.3% in December³ after posting mostly strong prints during 2014. However, industrial production rebounded in January by 0.2% despite weakness from the energy sector. This suggests to us that the manufacturing sector remains healthy.

In our opinion, the gain in the 10-year Treasury yield could have been even greater had it not been for Congressional testimony by U.S. Federal Reserve (Fed) Chair Janet Yellen. While we do not think the testimony added clarity to the timing of liftoff from the Fed’s zero interest rate monetary policy, it did suggest that “patience” may be removed from its forward guidance. Yellen was clear in her prepared remarks that if “patience” is removed, it does not mean rates will rise immediately thereafter but that “… conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting.”⁴ While some market participants regarded her overall message as dovish, we see it as more neutral and providing the Fed more flexibility as new data comes in.

We look for increased volatility in U.S. international trade data. A worker slowdown in the West Coast ports has likely delayed shipments both into and out of the United States.⁵ Dismissing the slowdown just because it has ended would be premature, in our view. The effected ports comprise over half of all containers used in international trade⁶, so we think any underlying volatility in the trade accounts and the downstream impact on the net export component of GDP should be dismissed as temporary. We see the strong dollar and negative import prices as larger negative factors to net exports in 2015.

Inflation remains the biggest thorn in the side of U.S. economic data, with oil-price declines pushing the January headline CPI (Consumer Price Index) print below zero⁷ for the first time since 2009, a period during and immediately after a major recession. On the other hand, core CPI rose 0.2% and beat market expectations of 0.1%. Shelter remains a key support, but other areas also came in less negative, such as apparel and used cars.

Turning to international developments, Greece’s request for a bailout extension from the rest of Europe made a big splash.⁸ The tentative agreement between the sides provided Greece a four-month extension, but it must continue down the reform path. We see this as just kicking the can down the road. The next showdown will occur at the end of June or early July when Greece’s interest payments increase, according to our analysis. We come away from this situation mainly thinking that the path forward is likely to be turbulent between now and the end of the extension, rather than the hoped-for clarification.

Footnotes

1. Bloomberg, ticker = USGG10YR Index, as of February 25, 2015

2. U.S. Bureau of Labor Statistics, Employment Situation Report, February 6, 2015

3. Federal Reserve, Economic Research & Data, Statistical Releases and Historical Data, February 18, 2015

4. Federal Reserve, News & Events, 2015 Testimony, Semiannual Monetary Policy Report to the Congress, February 24, 2015

5. http://www.nbcnews.com/business/business-news/ports-workers-face-huge-backlog-after-dispute-ends-n310346

6. Port Authorities, Haver, February 19, 2015

7. Bureau of Labor Statistics, Consumer Price Index, Press Releases, February 26, 2015

8. http://www.reuters.com/article/2015/02/19/eurozone-greece-request-idUSL5N0VT2S720150219

Disclosure

The forecasts, opinions and estimates expressed in this report constitute HIMCO’s judgment as of February 27, 2015 and are subject to change without notice based on market, economic and other conditions. The assumptions underlying these forecasts concern future events over which we have no control. The assumptions may turn out to be materially different from actual experience. There is no guarantee that any forecasts made will come to pass. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. Sectors referenced should not be construed as a solicitation or recommendation or be used as the sole basis for any investment decision. All data contained in this material is from sources deemed to be reliable, but cannot be guaranteed as to accuracy or completeness. All investments are subject to risk, including possible loss of principal. Fixed income investments are subject to credit and interest rate risk. Investments in high yield and foreign securities involve risks beyond those inherent in higher-rated and solely domestic investments. These risks are magnified in emerging markets. To the extent that a strategy invests in asset-backed, mortgage-backed or commercial mortgage-backed securities, its exposure to prepayment and extension risks may be greater than investments in other fixed income securities.

Hartford Investment Management Company is a registered investment adviser subsidiary of The Hartford Financial Services Group, Inc. (SEC registration does not imply a certain level of skill or training; nor does it imply that the SEC has sponsored, recommended, or otherwise approved of HIMCO).

HIMCO is not affiliated with Advisors Asset Management, Inc. (AAM). AAM was not involved in the preparation of this article, and the opinions expressed herein do not necessarily reflect those of AAM.

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