Tag Archives: Markets

Fed on the ropes but not down

The US Federal Reserve and markets have been engaged in a bruising duel for the past six months. Round 6 should have been an easy one for the Fed given reasonably well behaved equity and FX markets, surging energy prices and signs that global GDP growth was stabilising.

But softer US employment data for May have put the Fed on the ropes, with markets having now all but priced out a hike next week and only pricing in a 24% probability of a hike on 27th July.

The Fed is not down, however, thanks to decent earnings, income and spending, a pick-up in most inflation measures in April and a robust housing market, which all point to a rebound in GDP growth in Q2.

In the labour market, an increasingly high percentage of those who want a job are finding one and the steady share of full-time employees points to decent hourly earnings growth in months ahead. There is still slack but arguably less than in December when the Fed hiked.

The Fed will be hoping that the next data set, particularly for the labour market, manufacturing and inflation, will go its way so that it can finally deliver a second-hike in a decade at its July meeting.

This is still my core scenario, although if labour data for June disappoint the Fed may well turn to its 21st September meeting as its next possible trigger point.

A July or September hike would leave the Fed with another few rounds to hike its policy rate by another 25bps, in line with Fed members’ current average forecast of two hikes in 2016. The Fed will want to show markets that it will not be swayed by soft data punches or temporary market developments and is still in control, but without flooring markets. Read more

US Economy Not at Full Employment

Markets, which tend to focus on US non-farm payrolls and the unemployment rate, may be relying on an incomplete and arguably inaccurate picture of the US labour market which fails to fully take into account a still sizeable pool of available workers.

Job creation has been robust in recent years, but the working age population has also increased while the share of full-time employees remains modest. As a result, the ratio of the working-age population employed in full-time jobs, currently 48.7%, remains well below its historical average.

Importantly this ratio tends to lead the growth rate in private sector employees’ hourly earnings and points to earnings growth only rising modestly in coming months from around 2.4% year-on-year.

The policy implication, all other things being equal, is that the Federal Reserve may not have to worry near-term about a tight labour market boosting pay-packets and in turn wage-led inflation. With US GDP growth having collapsed in Q1, global growth having slowed further to around 2.6% year-on-year and global PMI and Chinese trade data showing little bounce in April, the Fed’s decision to keep rates on hold so far this year is at least defendable.

My core scenario of one or two Fed rate hikes this year remains feasible but my expectation that the Fed would pull the trigger in June will likely be proven wrong. The Fed fund futures market has all but discounted a mid-year hike, currently pricing in a probability of only 8% for a 25bp hike, versus 23% back on 26 April. Read more