US JOBS NUMBER DECLINE. FEDERAL RESERVE BALANCE SHEET NORMALIZATION CONTINUES

By Musabbir Mazhar

In the US, the jobs report came out with non-farm payrolls increasing 20,000 for the month of February 2019, which largely falls short of market consensus expectations of 192,000 jobs. This is not good news – to put into perspective, the average job increase was 223,000 each month in 2018 and 311,000 (revised from 304,000) increase in January 2019. This could add to the cautionary and less hawkish tone of Fed Chairman, Jeremy Powell, and reduce expectations of the rate of increase of the fed funds rate.

The S&P 500 was at 2,743 points on 8th March 2019, down 0.2% at the close of the day from previous day. The low job numbers are usually bad news for the markets but this is, albeit an important one, only one of the factors in the current market conditions. The 10 year Treasury rates were at 2.62% on 8th March 2019, down 14 basis points in the last one week.

The following table shows S&P 500 levels and returns:

The unemployment rate improved, however, from 4% in January 2019 to 3.8% in February 2019. This improvement could be attributed to the fact that the government workers who were laid off temporarily in January due to government shutdown, returned to work.

Let’s turn to the Fed for a tad bit.

The fed funds rate, which is the inter-bank overnight borrowings rate for unsecured funds in US dollars, is at 2.4% currently. This has been as a result of the goal to keep the target rate range within 2.25% to 2.50%, which was last brought to this level by the 25 basis points rate hike on December 2018. The rate influences short term and long term borrowing rates in the market which ultimately influences the economy, business and household spending.

How did we get here? At the last financial crisis, the fed fund rates were lowered to rock bottom, to the target rate range of 0% to 0.25% in December 2008 from levels of 5.25% in early 2007 including use of Open Market Operations, that is Reverse Repurchase Agreements (REPOs) and other monetary policy tools. This was followed by Large Scale Asset Purchases by the Fed (known as Quantitative Easing) starting in 2009 since at 0% rate, the fed funds rate had no room to go lower. The fed purchased long term Treasury and mortgage securities of about $3.7 Trillion USD by 2014. The fed started increasing the fed funds rate in December 2015; and began the Fed’s balance sheet normalization in 2017 by decreasing the reinvestment of payments received from the asset purchases.

The Federal Reserve announced yesterday, 8th March 2019, that they might be able to reach the normalized balance sheet by end of 2019. However, what is normal and when that will be achieved is still being determined under current market developments. The Fed continues to keep its 2% inflation target.

I would imagine that the fed will lower the frequency of the the rate hike, compared to 4 times in 2018 and 3 times in 2017 that they have increased the rate, as they have indicated that they would take decision based on data and as market conditions warrant.