When world equity markets got spooked at the end of January and beginning of February, it was inflation concerns that seemed to start the selling and caused a big spike in volatility. We saw the longest stretch without a five percent correction come to a halt and February ended up being the second down month for the indices in the since November ’16.
Earlier today the personal consumption expenditures (PCE) price index was released and it showed an increase of 0.2 percent from December to January and the increase from one year ago was only 1.5 percent. The Fed’s target inflation rate is 2.0 percent.
The big concern for investors is that with the labor market being so tight, wages will start to increase and this will cause inflation to shoot up faster than anticipated. The thought process being that if inflation jumps, it will cause the Fed to raise rates more than expected and faster. Along these lines, personal income for January was up 0.4 percent and initial jobless claims came in at 210,000. That is the lowest reading for initial claims since 1969.
The February employment report comes out next Friday and all eyes will be on the job growth, unemployment rate, and hourly earnings. January’s report showed unemployment at 4.1 percent and a month over month increase in hourly earnings of 0.3 percent. The year over year increase in hourly earnings jumped to 2.9 percent and that is the biggest increase we have seen in several decades.
Economists have pondered how low the unemployment rate can go before being considered full employment and thus causing a big spike in inflation, but no one really knows. In yesterday’s testimony in front of Congress, new Fed Chairman Jerome Powell mentioned 3.5 percent as the lowest imaginable rate of unemployment, but that he thought it could be higher than that.
With personal income coming in higher than expected and initial jobless claims coming in lower than expected, we could see an increase in hourly earnings and a drop in the unemployment rate in the February employment report. If both of these things happen, we could see more selling pressure in equities and additional selling in bonds, driving interest rates higher. I couldn’t find any analysts’ predictions for the February employment report that were available yet.
I would suggest that investors take a cautionary approach with their investment portfolios at this time. There are too many variables that could drive stocks lower and far fewer that could drive stocks higher in the current market environment.