Markets confused over Fed’s next move

Posted on September 2, 2016

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The latest batch of US employment data has proved a real Rorschach test for financial markets, with bonds, currencies and stocks veering in different directions as investors mull the Federal Reserve’s next move.

The US economy created 151,000 new jobs last month, missing the 180,000 average estimate of economists polled by Bloomberg, while wage gains were also more muted than expected. For some investors, the disappointment killed the chances of a September interest rate increase.

    “This should cool speculation about a September hike,” Aberdeen Asset Management’s Luke Bartholomew said in a note. “The signal from last week’s Jackson Hole meeting was that investors should expect a rate hike sooner than they had been expecting. This report is certainly not disastrous but it’s probably not enough to convince the doves around Yellen that the Fed needs to raise rates just yet. December is once again shaping up to be the mostly likely date of the next hike.”

    The US stock market rose 0.5 per cent after the data were released, and the interest rate futures market pared back the implied odds of a September increase to as low as 22 per cent, from 40 per cent earlier this week. The implied probability edged up to 32 per cent by midday in New York but some economists felt that the sharp reversal from the previous month’s buoyant 271,000 growth imperilled rate hikes even later this year.

    “This lowers the probability for both a September and a December rate hike,” said Citi’s Andrew Hollenhorst. “Investors will probably expect some upward revision to the August payrolls gain in future months, implying the probability of a December hike should fall by less than that of a September hike.”

    However, other markets interpreted the non-farm payrolls report differently. Most notably, the dollar clawed back its initial post-release losses and the main DXY dollar index was up 0.2 per cent by midday in New York, while the 10-year US Treasury yield rose 5 basis points to 1.61 per cent. Bank stocks, which benefit from rising interest rates, lagged behind the broader stock market but still rose back to near a nine-month high.

    Goldman Sachs’s Jan Hatzius pointed out that last month’s job creation was still above the Fed’s “break-even rate” — the level needed to keep the unemployment rate steady — and raised his odds on a September rate increase from 40 per cent to 55 per cent. “We therefore see this report as just enough for a large majority of officials to support a September rate increase,” he wrote in a note.

    Pace of US jobs growth slows

    A job seeker writes down his contact information at the Sears Holdings Corp. booth at a Recruit Military veterans job fair in Cleveland, Ohio, U.S., on Thursday, Sept. 1, 2016. Fewer Americans than forecast filed applications for unemployment benefits last week, a report from the Labor Department showed on Thursday. Photographer: Luke Sharrett/Bloomberg

    Economy gained 151,000 jobs in August, missing estimates

    The August report is notorious for often initially missing on the downside only to be chalked up later. Goldman Sachs points out that the initial reading has missed the consensus forecast by an average of 49,000 jobs since 2011, only to be revised up by an average of 71,000 in subsequent releases.

    If that pattern holds, it would confirm that the US economy is still creating jobs at a healthy clip, and ramp up the likelihood of wage gains, quicker inflation and eventually interest rate increases.

    Fed watchers also differ on the longer-term outlook. While Capital Economics’ David Rees reckons that the US central bank will stay its hand in September and only raise rates in December, he argued that the strength of the labour market would eventually force the Fed to tighten monetary policy quicker than markets expect.

    “It seems to us to be only a matter of time before wage growth shows more sign of life,” he wrote. “Coupled with a probable improvement in the incoming economic data, we expect this to persuade the Fed to lift rates as soon as December, and that the tightening cycle will eventually be much more aggressive than is currently discounted in markets.”

    However, Rick Rieder, head of fixed income at BlackRock, the asset manager, said that the Fed was willing to let inflation “run hotter” and accelerate beyond its 2 per cent target without intervening with more aggressive rate increases.

    “We think the data today makes a number of tangible patterns and trends clearer, and is likely to keep the Fed on a path toward interest rate normalisation. Still, that path will be very deliberate over time,” he said.

    On the whole, Friday’s jobs report has provided Fed watchers plenty of evidence to back their views — whatever they may be — but in truth provided little real clarity on what policymakers will do when it next meets on September 21.

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