It was a choppy week for the equity markets, but most major indexes gained ground. The S&P was up +0.6% for the week while the NASDAQ added +0.9%. Only small-caps and energy stocks really lost ground. Europe had a very good week. Germany was up +2.4% while France added +3.1%. Japan was solid as well (+1.3%).
Interest rates backed up slightly after the Fed meeting mid-week. The yield on the 10-year increased 7bps and intermediate-term government bonds lost -0.6%. The yield on the 2-year inched up to 1.31% as the short end of the yield curve moved to price in a June Fed Funds hike.
Oil prices struggled, losing -5.6%. Crude is now down over -11% YTD. Energy stocks are off a similar amount this year (chart below), while oil services stocks have been hit with a -17% loss.
Precious metals were similarly weak. Gold lost -3.1%, silver -4.9%, and gold stocks -3.1%.
An Economy at Full Employment…
The main economic news for the week was Friday’s jobs report. It proved to be a solid report as job growth bounced back from last month’s disappointment. Specifically:
- The US economy added 211,000 jobs in April compared with expectations of 190,000.
- Payrolls for March were revised down to a gain of 79,000 jobs, compared with an earlier estimate of 98,000.
The unemployment rate fell to 4.4% from 4.5% (see below). This is the lowest level in a decade.
- The labor force participation rate, a measure of the working-age population that is either employed or seeking work, dipped to 62.9% from 63% (this pushed the unemployment rate down slightly).
- Wage growth softened a bit. Wages grew by 2.5% in April, down from 2.6% the previous month. This was the weakest pace since August 2016 (see below).
…Means the Fed is On Track to Hike in June
The jobs report naturally brings us to the Fed. They held another meeting this week and chose to leave the target range for the funds rate unchanged, as widely expected. The post-meeting statement acknowledged but downplayed weak GDP growth in Q1 and made no changes to the discussion of balance sheet policy.
All in all, a yawner of a meeting. But they did send a pretty strong signal that a hike in June is about as close to a done deal as they come. There was some thought that the weak 1st quarter growth number might make them wait, but by downplaying the issue the market took this as a sign that the Fed Funds rate will be hiked by a quarter point at the June meeting. The odds of a hike surged to almost 100% post meeting, as you can see below.
A quarter point hike will take the rate to a range of 1.00% to 1.25%. It’s been a long time since cash has yielded 1%!!!
Oil Slumps (again)
Oil prices took it on the chin this week, falling a hefty -5.6%. Crude is now back to levels last seen in November, as you can see below.
On the surface one might have thought prices should have gone up this week. After all, the U.S. Energy Information Administration (“EIA”) reported crude-oil inventories unexpectedly declined by 930,000 barrels to 527.8 million barrels last week. Typically, this would be seen as a bullish development. However, oil prices plunged on the news.
What should we make of this?
The answer likely has to do with gasoline. The EIA also reported gasoline inventories rose by 191,000 barrels to 241.2 million barrels last week. This is more than 10% higher than the seasonal average over the past 10 years. It appears the recent drop in oil inventories was driven by refineries ramping up gasoline production. But it’s important to note that this move isn’t being driven by rising demand.
In fact, gasoline demand has been falling for three straight weeks. In other words, this trend isn’t sustainable… Some of the glut in oil supplies has simply moved into gasoline supplies instead. But unless demand suddenly returns, it’s only a matter of time before refiners cut their crude oil purchases and oil inventories will once again shoot higher.
Another issue has to do with U.S. shale producers. There is a growing realization that their marginal cost of production might only be around $45 a barrel. Only a couple of years ago this number was thought to be over $70. This means every time oil moves above $45, shale producers can turn the taps on. This is a tough environment for oil bulls who see $60 or $70 oil in our future.
Maybe the French have it Right – 5 weeks of Vacation and 2 Rounds of Voting
There is something to be said for the French system. When it comes to Presidential elections, they have an opening round of voting where emotions run rampant and all sorts of crazy candidates throw their hats into the ring. But once the fun and games are over, they have a second round where more sober judgments are meant to win out.
On Sunday, the second round of the French election takes place, and the National Front’s Marine Le Pen trails her liberal opponent, Emmanuel Macron by a hefty 20 points. European markets have greeted a likely Macron win warmly, with equities posting an impressive rally since the first round, and the euro hitting multi-month highs (see below).
While a Macron win is likely, Le Pen’s electoral gains over the last few years has been impressive. Her anti-finance, anti-globalization, anti-euro, anti-immigration platform resonates in France, as it does in many other countries. As The Economist notes:
“It is a message that chimes with a big chunk of the electorate in a fractured country. Big cities and college-educated voters favour Mr Macron and his pro-European, business-friendly politics, while struggling smaller towns and rural parts lean to the protectionist, anti-immigration Eurosceptism of Ms Le Pen. Even some of those who recoil at her xenophobia turn out to loathe the world of finance even more. ‘Neither banker, nor racist’ read a banner at a protest rally in Paris.”
A Le Pen loss doesn’t mean her movement dies. Far from it. She’s made some impressive gains the last few years, aided in no small part by the 2008/2009 financial crisis. Again, The Economist:
“Yet it would be a mistake all the same to understate Ms Le Pen’s achievement. With a first-round score of 7.7m votes, she has already set a historic record for the FN (see chart). In 2002, when her father, Jean-Marie Le Pen, also made it into the presidential run-off, there were demonstrations across the country and his opponent, Jacques Chirac, swept up 82% of the vote. This time, the streets have been mostly quiet, and she looks set to double his score.”
And it doesn’t seem much of a stretch to say that when the next global recession hits her movement’s popularity will jump once again. BCA notes that there is a strong correlation between unemployment rates in various French departments and support for Le Pen’s National Front (see chart below).
But this will be a story for 2019 or 2020. For now, European political risk has gone on the backburner.
Have a good weekend.
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