Morning Report: The economy added 742k jobs in March

Vital Statistics:

 LastChange
S&P futures4,17720.8
Oil (WTI)66.440.77
10 year government bond yield 1.60%
30 year fixed rate mortgage 3.13%

Stocks are higher as commodity prices continue to rise. Bonds and MBS are flat.

Janet Yellen caused a stir in the markets yesterday when she said that interest rates may have to rise somewhat to prevent overheating in the US economy. She later walked back that comment (the Treasury Secretary is not supposed to be suggesting policy to the Fed), and clarified her statement. Regardless, the Fed Funds futures are handicapping at least a chance of a rate hike this year despite the language out of the Fed that the labor market is nowhere near ready for rate hikes.

The private sector added 742,000 jobs in April, according to the ADP Employment Survey. Roughly a third of these jobs were in leisure / hospitality however employment grew is pretty much every category. Note that the Street is looking for about 940,000 jobs in Friday’s Employment Situation Report, so that estimate could be a touch high.

Mortgage applications decreased modestly last week as purchases fell 3% and refis were basically flat. “There was a mixed bag of action in the mortgage market last week,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “Mortgage rates were slightly higher, refinance applications were essentially unchanged and purchase applications fell for the second straight week. Both conventional and government purchase applications declined, but average loan sizes increased for each loan type. This is a sign that the competitive purchase market, driven by low housing inventory and high demand, is pushing prices higher and weighing down on activity. The higher prices are also affecting the mix of activity, with stronger growth in purchase loans with larger-than-average balances.”

The MBA refinance index is below. You can see we are still quite elevated compared to historical numbers

Factory orders rose 1.1% in March. Part of the uptick we are seeing in inflation is due to inventory restocking. In many ways, this is reminiscent of the economy back before things like just-in-time inventory management and globalization. The economy would expand, companies would aggressively build inventory to compete, inflation would rise, which would trigger a response from the Fed, which would cause a recession and then the cycle would repeat.

For companies, inventory is a big use of cash, so they try to minimize it. Technology and data allowed them to use just as much as was necessary to meet demand, which improved cash flows. The COVID-19 pandemic revealed some of the issues with that model, and perhaps we will see some sort of reversal. These issues won’t necessarily show up in corporate financials as increased costs as much as they will manifest as lost opportunities.

I suspect the re-adjustment to this will take years and this will improve economic performance over the next few years. The big question revolves around commodity prices and whether they trigger inflation. My guess is they will not, as producers will invariably ramp up production and energy demand can be met quickly. People forget that 10 years ago, oil was trading around $125 a barrel. Lots of wells were drilled then that can be turned on pretty quickly.

Commodities rallied hard 10-15 years ago, driven by insatiable demand for everything out of China. We didn’t see a wave of consumer inflation then, though we did see a wave of asset inflation, especially real estate. Regardless, the Fed generally views commodity-push inflation as transitory and will probably not react to it. The economy should be relatively strong over the next few years, driven by inventory build, and housing.

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