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Promising Jobs Report Indicates Modest Growth

The February employment report came in stronger than expected at the beginning of March. The Federal Reserve (the Fed) likely will end quantitative easing by November, but not consider raising interest rates until the second half of 2015.

What the Report Said

The payroll report released on Friday, March 7 reported job growth of 175,000 in February.
This was better than expected, and especially encouraging since the December and January job numbers were revised upwards by a total of 25,000 jobs.

While the monthly employment reports can be a series subject to errors and revisions, the 3-month and 12-month rolling averages reveal a fairly consistent growth pattern across most of 2012 and 2013.

The unemployment rate rose from 6.6% to 6.7%, while the labor force participation rate remain unchanged at 63%. The percent of part time workers for economic reasons changed little to 7.2%, while the number of marginally attached workers declined, leaving a large pool of underemployed workers. Additionally, average annual earnings rose a modest 2.5% on a year over year basis.


What It Means

The February numbers are consistent with the rolling 12-month average of 170,000-200,000 new jobs the economy has been creating since January 2012. We still expect modest growth as the year progresses, with annual Gross Domestic Product (GDP) growth for 2014 reaching 2.8%, job creation averaging over 200,000 new jobs a month, inflation moving toward the Fed target of 2%, and the yield on the U.S. Treasury 10-year note reaching 3.25% by year end.

We believe that the recent data flow, given the bad weather, is consistent with our outlook. Senior Fed members have communicated a strong bias toward tapering, but the Fed will remain data dependent. Faster growth than the current consensus could result in the Fed moving to raise interest rates earlier than currently expected. We believe it would take an extreme downward movement in growth and job creation for the Fed to suspend tapering.

The Fed's decision to replace quantitative easing with forward guidance will contribute to the increase in market volatility as market participants trade around short-term data.

What We Think

Duration risk is not being rewarded enough in the marketplace, and investors should consider looking to take on credit and liquidity risk. We expect further spread compression in a faster-growing, low inflation environment, which should offset in part the expected upward movement in interest rates.

Equities could offer better return prospects than fixed income. Investors may expect equity returns to be in the high single digits in the medium to long term, though. We predict low single digit commodities futures returns, with moderate growth and low inflation likely to continue in 2014. Volatility will increase as quantitative easing comes to an end and we move closer to the expected date of the Fed's first interest rate hike.

For more weekly and quarterly economic commentary, visit principalfunds.com/commentary.

 

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