December Rate Hike a Certainty – Or Maybe Not?

by the Curmudgeon




On Friday, the U.S. Bureau of Labor Statistics reported that non-farm payrolls increased by 271,000 - the strongest rate of job creation this year.  Job gains in August and September combined were revised up by 12,000. The unemployment rate ticked down to 5% - a tad above the 4.9% level that Fed officials regard as the long term full employment rate.


Equally important for the Fed, wages rose at their strongest clip since 2009, with average hourly earnings rising 2.5 % over the year.  That's comfortably above the 1.5 to 2.3% band of the past six years. While the Fed has not set accelerating wages as a precondition for rate rises, it has set a 2% inflation rate target and sees wages as an important indicator of labor market slack or tightness.


The pace of job growth in the past three months has averaged 187,000 per month, slower than the 210,000 pace in the first half of the year but still strong progress.  Wage growth of 2.5% is solidly in the direction of an increase in the inflation rate, which the Fed needs to see to justify a rate rise.


Market (Over) Reaction:


Friday's employment report numbers triggered a sharp rise in bond yields, with the two-year Treasury yield jumping to a five-and-a-half year high as traders priced in a Fed rate increase at their Dec 16th meeting. The dollar also shot up, with the Euro 1.4% lower against the US currency at $1.0736 while UK pound sterling was down 0.9% at $1.5076. The DXY dollar index was up 1.2%.  Gold fell 1.6% to well below $1100 with many gold mining shares down over 5%. The FT reports that Gold mutual funds lost $700m, their largest outflow in three months. All that despite Fed Chairwoman Janet Yellen strongly hinting at a December rate increase in her “live possibility” comments to Congress this week.


The dollar trade-weighted index is at its highest since April, and has appreciated by 7.26% since the August low. The JPMorgan emerging markets currency index is down 2.86% over the past month after a brief recovery, and down 13% for the year. Industrial metals prices, central for many emerging market economies, continue to plumb new lows.  A good benchmark for industrial metals is BHP stock which is 8% BELOW the level it was 10 years ago!


December Rate Hike Looks Like a Slam Dunk:


Compared with previous economic recoveries, the Fed is already way behind the curve when judged by the 5% unemployment rate or duration of the current economic “expansion.” The last rate-raising cycle kicked off in July 2004, when the unemployment rate was 5.5%.  The majority of voices strongly suggest the Fed will hike rates at the December FOMC meeting.


If the FOMC were meeting today they would be tightening,” said Jim O’Sullivan, an economist at High Frequency Economics, referring to the Fed’s rate-setting committee. “This is an unambiguously strong report.”

“The report was so strong and broad-based that it will be difficult to deter them from raising rates,” said Michael Gapen, chief United States economist at Barclays. Until Friday, Barclays had been predicting the Fed would wait until March 2016 to act, but moved that up to next month after Friday’s announcement. “I think the odds are about 80 to 85 percent that they will move,” Mr. Gapen said.


Rob Carnell, an economist at ING, said it would now take a “catastrophically bad” jobs report for November for the Fed to not raise rates on December 16th.


“Only a Crisis Can Stop the Federal Reserve,” wrote John Authers in his Nov 6th FT column (on-line subscription required):   “We can revert to assuming a rate rise from the Federal Reserve next month is a virtual certainty. There is no reason from the labor market for a central bank that plainly wants to raise rates from zero to stay its hand. The initial reaction in the Fed Funds futures market, which put the implied chance of a December rate rise up to 72%, looks understated.”




Curmudgeon Note:


According to the CME Fed Watch Tool, there is now a 69.8% probability of a ½ point Fed rate hike at the December FOMC meeting.  That's a substantial increase from one month ago when it was only a 4.6% chance.



Skeptics & a Dissenting Opinion:


Diane Swonk, chief economist at Mesirow Financial, said: “The (labor) participation rate is still not up. We still have a lot of people we want to re-engage. This gets to the next phase of monetary policy, which is walking the line of removing accommodation, but not so rapidly as to reduce re-engagement.”


Douglas Holtz-Eakin, an economic adviser to Republicans and former director of the nonpartisan Congressional Budget Office, wrote after the jobs report was released. “This represents real wage growth, which has been a missing ingredient. The only nit to pick was flat average weekly hours. The more interesting issue is whether the strong October report represents a one-time blip in the aftermath of the weak August and September performance, or is an early sign of growth that will remain above the 2.2 percent average since the recovery began.”


In a November 7th note to subscribers John Williams of wrote:


"Current market hype that October’s strong employment report locks in a December rate hike is nonsense. Not only was the report not that strong, there still is more than one full month’s worth of weak economic reporting ahead, including a likely much-weaker November payroll employment report on December 4th, all before the December FOMC"


His website offers more behind the numbers bullet points:


·       Any FOMC Rate-Boost “Certainty’ Resulting from October Jobs Reporting, Remains More Hype than Reality, with Meaningfully-Weak Data Ahead

·       Except for Even-Softer September Annual Growth, in Revision, October Payroll Growth Was at a 17-Month Low

·       Unusual, Unstable and Invisible Shifts in Seasonal Factors Helped to Boost or Skew Headline Payrolls

·       Headline Decline in Unemployment from 5.1% to 5.0% Was a Decline from 5.05% to 5.04%

·       October 2015 Unemployment: 5.0% (U.3), 9.8% (U.6), 22.8% (ShadowStats)

·       Broad Annual Money Supply Growth Continued to Slow


Curmudgeon Conclusions:


In over a half century, I've never seen global markets so obsessed with a 25bps Fed Funds rate hike -- the first in over nine years!  Even though the Fed has given guidance and hints that it would raise rates “gradually” starting this year, every Fed comment and employment report seems to create a huge market reaction, especially the recent six trading day uninterrupted sell-off in December Gold futures - from a high of $1190 to Friday's close of $1088.90.  In years past, gold increased FASTER than interest rates when inflation was rising, as it appears to be from the year over year 2.5% growth in wages.


As Victor has pointed out in numerous Curmudgeon posts, a ¼ point Fed Funds rate hike means nothing for the real economy.  I've repeatedly stated that such a rate increase is irrelevant.  Banks are flush with excess reserves from numerous rounds of QE and so don't have to borrow from one another (via the Fed Funds rate) or at the discount window (via the Fed Discount rate).  So while we think this is much ado about nothing, the markets disagree. 


Till next time…


The Curmudgeon


Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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