MarketView for June 5

 

Summary

 

The Dow Jones industrial average and the S&P 500 ended at new record highs on Thursday after the European Central Bank cut rates to record lows and pledged to do more if needed to fight off the risk of deflation. Now Wall Street has its eyes focused on Friday's Jobs report for May. It is expected to show job growth slowed last month and the unemployment rate ticked up, but not by enough to upset the view that the economy is bouncing back. The number of Americans filing new claims for unemployment benefits rose last week, but the underlying trend continued to point to a firming labor market.

 

The day's gains were broad, with all ten S&P 500 sectors ending higher. Industrials rose 1.1 percent and financials 0.9 percent. The day's weakest sector was telecom, considered a defensive group, which rose less than 0.1 percent. With Thursday's advance, the S&P has now gained ground in nine of the past 11 sessions, up 3.6 percent over that period, and ended at a record high five times in the past six sessions.

 

The ECB cut the deposit rate to -0.10 percent and launched a series of measures to pump money into the sluggish euro zone economy. It stopped short of full-fledged quantitative easing (QE) - printing money to buy assets - but ECB President Mario Draghi said more action would come if necessary.

 

Amazon revived speculation about its next major product on Wednesday, using a mysterious YouTube video and website post to tease about a June 18 "launch event" in Seattle to be hosted by CEO Jeff Bezos. Amazon ended the day up 5.5 percent to close at $323.57.

 

Word on the Street is that Sprint has agreed to pay about $40 per share to buy T-Mobile US, marking further progress in the attempt to merge the third and fourth largest mobile network operators. Sprint ended the day down 4 percent to close at $9.02, while T-Mobile fell 2.3 percent to end the day at $33.49.

 

Rite Aid fell 7.4 percent to $7.87 after it estimated first-quarter profit much below expectations. Ciena rose 18.4 percent to close at $22.48 after the company posted earnings that beat expectations and gave a revenue outlook above forecasts.

 

Approximately 5.91 billion shares changed hands on the major equity exchanges, slightly above last month's average of 5.75 billion shares, according to data from BATS Global Markets.

 

Underlying Trend in Labor Still Positive

 

The Labor Department reported on Thursday that the number of new claims for unemployment benefits increased a bit last week, but the underlying trend continued to point to a firming labor market. Initial claims were up by 8,000 claims to a seasonally adjusted 312,000 claims for the week ended May 31.

 

While jobless claims have been difficult because of seasonality issues and the need to adjust the data to take into account issues such as Easter and Passover, the data continues to suggest the jobs market is strengthening. Once again a Labor Department analyst said there were no special factors influencing the state level data.

 

The four-week moving average for new claims, considered a better measure of underlying labor market conditions as it removes week-to-week volatility, fell by 2,250 claims to 310,250 claims, the lowest level since June 2007.

 

Last week's data has no impact on the government's closely followed employment report for May, which will be released on Friday, as it falls outside the survey period.

 

The claims report showed the number of people still receiving benefits after an initial week of aid declined 20,000 to 2.60 million in the week ended May 24. That was the lowest level since October 2007.

 

So-called continuing claims have declined for five straight weeks, suggesting some long-term unemployed were finding work. The unemployment rate for people collecting unemployment benefits has held at 2.0 percent since April.

 

Labor Force Participation Rate Could Be Improving

 

For the first time in six years, the share of people who either have a job or are looking for one is on the rise. Most states have experienced sharp declines in labor force participation since the 2007-2009 recession but a Reuters analysis of government data found a reversal could be underway. The data bolsters Federal Reserve Chair Janet Yellen's view that America has ample room to create jobs without causing uncomfortably high inflation and it buttresses arguments for keeping interest rates low.

 

Anecdotal reports suggest that in many parts of the country, demand for labor appears to be growing enough to get people who had dropped out of the workforce to restart their job hunts.

 

Washington State is one of 32 states where the participation rate rose in the six months through April, according to the Reuters analysis. Together, these states account for a majority of the nation's working-age population. It was the second straight month where most states chalked up gains over a six-month period.

 

The data covering the 50 states and the District of Columbia is volatile, so it does not provide conclusive evidence of a bounce back in the labor force. However, since the start of the recession in December 2007, the direction of participation rates has been clear: they have been falling. It has been rare in recent years for more than a handful of states to show improved labor participation over any six-month period. Now there's evidence the pendulum may be swinging back.

 

The gains are spread across the country - from states with rebounding construction industries like Florida and Utah to those with job growth in health care and education like West Virginia. The Fed's Beige Book of anecdotal economic reports for May, which was released on Wednesday, said the U.S. labor market "generally improved," with the central bank's Kansas City district reporting that businesses were now having to compete for workers, the Cleveland and Chicago districts noting an upturn in demand for temporary employees, and Atlanta pointing to a jump in the number of workers moving from temporary to permanent jobs. It said wage pressures remained "subdued."

 

Texas is another state making gains. Blessed with robust economic growth, the speed with which unemployed Texans find jobs is nearly twice as high as in the rest of the country, a dynamic that is coaxing discouraged workers from the sidelines, Dallas Fed economist Anil Kumar told Reuters. He expects a similar pattern will emerge nationwide. "As the economy continues to improve, at least some of the people (will) be drawn back into the labor force," Kumar said.

 

Whether or not they return could be vital for the strength of the U.S. economy, for the behavior of inflation, and for the path of monetary policy. The U.S. jobless rate has declined steadily over the last four years, but much of the drop was due to people giving up the hunt for work, which means they were no longer counted as unemployed.

 

In April, the national participation rate fell to 62.8 percent, revisiting a 36-year low reached late last year, although a report on Friday is expected to show it ticked up in May. During 2007, before the financial crisis and the recession, it was as high as 66.4 percent. Some of the decline has been due to an aging workforce and the retirement of baby boomers, a fact that may well keep participation from ever bouncing back to its pre-crisis level.

 

However, some dropouts went to college and are bound to eventually restart job hunts. Others grew frustrated at the lack of available jobs, but may decide to try their luck again if the economy continues to improve.

 

Some prominent economists, including former White House adviser Alan Krueger, argue that many of the folks on the margins of the labor force are not coming back. If that is true, higher inflation, fueled by rising wages, could come sooner than the Fed expects.

 

But Yellen, who took the helm at the Fed in February, has refused to write off Americans who have suffered long bouts of unemployment or given up the search for work entirely. She argues there is more slack in the economy than suggested by the nation's 6.3 percent unemployment rate, a key reason the Fed is expected to bide its time before hiking rates.

 

Along with the drop outs and record number of long-term unemployed, millions are working in part-time jobs even though they want full-time work - another fact Yellen has cited.

 

Job creation on its own is no guarantee that the country's labor pool will stabilize or expand. But recent research has held out some hope by focusing on the fate of the long-term unemployed - a group that, by historical standards, currently accounts for a disproportionate share of the unemployed.

 

If they were to grow frustrated and stop looking for work, they would drive the participation rate even lower. But research by both Goldman Sachs and the Fed indicates they are beginning to find jobs, gravitating, for example, to part-time work as a "stepping stone" to full-time employment.

 

ECB Finally Takes Action

 

The European Central Bank launched a new program on Thursday to fight low inflation and stimulate the euro zone economy. Specifically, it is cutting rates, imposing negative interest rates on its overnight depositors and offering banks new long-term funds.

 

The ECB reduced all its main interest rates to record lows in a drive to fight off the risk of Japan-like deflation and bring down the euro's exchange rate. For the first time, it will charge banks 0.10 percent for parking funds at the central bank overnight. However, it stopped short of large-scale asset purchases known as quantitative easing for now, but ECB President Mario Draghi said more action would come it necessary.

 

Draghi outlined a four-year 400 billion euro ($544.86 billion) program giving banks that have been holding back credit due to looming stress tests an incentive to increase lending to businesses in the euro zone. The package, adopted unanimously, was aimed at increasing lending to the "real economy", he said.

 

Other steps included extending the duration of unlimited cheap liquidity for euro zone banks, injecting about 170 billion euros by stopping tenders that withdrew funds spent on past government bond purchases, and preparing for possible future purchases of asset-backed securities to support small business.

 

Projections published by the ECB showed inflation would be just 0.7 percent this year, 1.1 percent next year and 1.4 percent in 2016, a downward revision and far below the ECB's target of below-but-close-to 2 percent.

 

Financial markets appeared to be in favor of the ECB measures. The euro fell to a four-month low of $1.3505, down about one cent, while European shares rose and yields on the government bonds of stressed euro zone countries fell.

 

Draghi said interest rates would stay low for a prolonged period but after Thursday's cut, he omitted a previous regular line that they could go lower. Asked how long it would take for the measures to work their way through into the economy, he said: "Most likely we will see immediate effects in the money markets and we will see delayed effects in the real economy attributable to this program ... It will probably take three or four quarters."

 

The ECB lowered the deposit rate to -0.1 percent. It cut its main refinancing rate to 0.15 percent, and the marginal lending rate - or emergency borrowing rate - to 0.40 percent.

 

Euro zone inflation has been stuck in what Draghi has called "the danger zone" below 1 percent since October, mainly because of weaker commodity and food prices, but also because of wage and other adjustments in euro zone crisis countries.

 

The stronger euro exchange rate exacerbates these dynamics. At the same time, record low interest rates are still not feeding through evenly to companies across the currency bloc. Companies in Portugal, for example, are paying on average 5.4 percent on loans compared with 2.2 percent in Finland or France. This particularly affects smaller companies, which rely strongly on bank funding and make up the bulk of the economy. ($1 = 0.7341 Euros)