The economy grew “moderately” and the labor market continued to strength last year, Federal Reserve Board Chair Jerome Powell said in the latest monetary policy report, submitted to Congress on Friday. While downside risks to the outlook have “receded somewhat,” the coronavirus is a new concern.
“Downside risks to the economic outlook seem to have receded somewhat in the latter part of 2019,” the report says. “Labor market conditions and economic growth in the United States have been resilient to the global headwinds in 2019, and conflicts over trade policy diminished somewhat toward the end of the year. Economic growth abroad also shows signs of stabilizing, though the coronavirus outbreak presents a more recent risk.”
And while threats have receded, “foreign financial, economic, and political developments could pose a number of near-term risks to the U.S. financial system,” Powell said.
China is vulnerable, and given its size, “significant distress in China could spill over to U.S. and global markets through a retrenchment of risk appetite, U.S. dollar appreciation, and declines in trade and commodity prices.”
Powell will follow up with appearances before the House Committee on Financial Services on Tuesday and the Senate Banking, Housing, and Urban Affairs Committee on Wednesday.
The questions from Congress may offer more information than the report. Lawmakers are likely to ask about the Fed’s balance sheet. “Lawmakers will be interested to know how the Fed plans to extricate itself from the repo market,” said Bill Zox, chief investment officer, fixed income, at Diamond Hill Capital Management. “While Powell will probably downplay the significance of the Fed’s recent balance sheet growth, lawmakers may be concerned about what happens when the Fed begins to slow down its asset purchases.”
Steve Frazier, president of Frazier Investment Management, suggests Congress will ask, given last year’s three interest rate cuts, how will the Fed "curb excessive issuance of low-grade corporate debt, which” Powell “noted was a concern for a possible economic downturn."
In a “special topic” in the report, which was released by the Fed Friday, Powell writes, “In general, a decline in manufacturing similar to that in 2019 would not be large enough to initiate a major downturn for the economy.” Plus, he notes, “after accounting for changing trends in growth of manufacturing output, mild slowdowns have often occurred during expansionary phases of business cycles.”
Historically, “a more pronounced contraction” in the sector occurs during a recession.
Job gains
Nonfarm payrolls rose more than expected in January and the December figure was revised up, but the unemployment rate ticked up, the Labor Department said Friday morning.
Seasonally adjusted, 225,000 jobs were added in the month, after 147,000 were added in December compared to the 145,000 initially reported. The unemployment rate rose to 3.6% from 3.5%.
“The unemployment rate remains at super-low levels across all ages, all ethnic groups, and every other grouping of workers,” said Lawrence Yun, National Association of Realtors chief economist. “That’s due to the unrelenting 20 million net job additions for over a decade since 2010.”
“Wages grew at 2.9% on a year-over-year basis in December 2019, but firmed to 3.1% in January,” noted Joel Kan, Mortgage Bankers Association associate vice president of economic and industry forecasting. “Increasing wage growth is a welcome sign for households looking to buy a home this spring.”
“225,000 jobs for January blew away the expectation of 165,000 jobs,” said Bryce Doty, a senior portfolio manager with Sit Investments. “Even the uptick of the unemployment rate from 3.5% to 3.6% was because of a good reason; the workforce participation rate increased from 63.2% to 63.4%.”
But the bond market need not sweat a possible rate hike from the Federal Reserve “given the uncertainty surrounding the economic impact from the coronavirus and the ongoing problems with the overnight repo market.”
And while the yield curve remains “inverted from T-Bills (1.58%) out nearly to the 10 year (1.59%),” he added, “This puts pressure on the Fed to cut and is another reason the strong jobs report isn’t causing yields to rise like you might otherwise expect.”
But despite the strong labor market, inflation remains below the Fed’s 2% target. “Investors don’t seem to believe inflation can rise despite strong economic data and higher than expected wage gains we saw in this morning’s report,” said Bill Merz, senior portfolio strategist and head of fixed income research at U.S. Bank Wealth Management. “This is one factor keeping rates low and the Fed accommodative. Chairman Powell expressed the FOMC’s frustration with persistently low inflation, but we’re still likely a ways away from the Fed considering a rate cut based solely on boosting inflation.”
And while the markets have priced in “high odds of a rate cut from the Fed this year,” Merz doesn’t expect one. “They are more likely to cut than hike, but that would require a meaningful downgrade of their economic outlook, which we don’t see happening in 2020.”
Separately, the Commerce Department reported wholesale inventories dropped 0.2% in December after a 0.1% rise in November, while wholesale sales fell 0.7% in the month after a 0.9% rise a month earlier.
