Booming US economy gives Fed confidence

We have seen from the October meeting of the Federal Reserve that conditions on the ground had improved dramatically, but not quite to the point where a rate hike could be justified.
The October statement was significant in that no mention was made of China weakness or emerging market economies. All obstacles have effectively been cleared so that the only determinants of a rate hike will be the strength of US data. Janet Yellen and other Fed policymakers have not minced their words in their determination to raise interest rates gradually as opposed to sharp and erratic hikes. On Wednesday, November 4, Yellen offered testimony in Washington DC where she outlined plans for a possible December rate hike.

FED TARGETS WITHIN RANGE
The Fed has several economic targets in mind, including a 4.9% unemployment rate and 2% inflation. Both of these measures are on track to being achieved, but are not quite there yet. On Friday, November 6, the figures for non-farm payrolls came in. The consensus estimate was 180,000, but the actual number of NFP jobs increased by 271,000. This figure marks the steepest gain since January. NFP jobs increased between January and February, then plummeted in March and gradually built up again. The decline began in May when 260,000 jobs were added and continued through to September when the number of NFP jobs added was 137,000. The present month saw a spike of over 134,000 jobs between September and October. The data is typically released on either the first or the last Friday of the month and has a significant impact on the USD. The US dollar index was trading at 99.15 for a gain of +1.9% after the news, close to the 52-week high of 100.39.
By the end of the trading week, the effect of the NFP jobs report helped the major indices to finish in the black. The Dow Jones Industrial Average closed at 17,910.33 for a gain of 1.4% for the week, the NASDAQ index closed at 5,147.12 for a gain of 1.8% for the week, and the S&P 500 index closed at 2.099.20 for a gain of 1% for the week.
As a result of the NFP, unemployment moved from 5.1% to 5%. The Fed target is well within range now, and this makes the likelihood of a rate hike in five weeks’ time a real possibility. That the US unemployment rate is at a 7.5 year low is significant and it shows that quantitative easing policies have worked in the US. In order to protect the economy from disinflation, and to retain a strong dollar, the Fed will likely move sooner rather than later. Of equal importance is the increase in hourly earnings, with a $0.09 increase recorded. The Fed effectively considers the current unemployment rate consistent with full employment. The figures that were released recently counterbalance the weakness of the previous two months.

REACTION TO THE US NFP REPORT
Markets didn’t waste any time reacting to the positive NFP report. The USD surged against a basket of currencies, and emerging market currencies plunged accordingly. It is becoming increasingly more evident to investors and currency traders everywhere that a rate hike is imminent. Such was the bullish sentiment in the futures markets that a 70% likelihood of a rate increase in December was recorded. Just a day earlier, that figure was 58%. So substantial was the NFP number for October that anything over 150,000 would have been considered grounds for raising the interest rate for the first time in nine years. Even those who opposed the rate hike, such as Chicago Federal Reserve Bank President Charles Evans, are now commenting that the US economy is substantially better. During September, a survey by Reuters found that 71% of banks dealing with the Fed expected a December rate hike, but that figure has now jumped to 88% of banks. If we are to go by market sentiment, it is clear that the trajectory for a liftoff is just ahead of us.

STRONG DOLLAR HURTS MANUFACTURING
Further good news was that upward revisions for August and September NFP jobs were also made. In fact, an additional 12,000 jobs were created during those months – significantly boosting sentiment vis-a-vis an economic uptick. Other important measures that increased include wages which have heretofore been rather stagnant. Wages are an important determinant of economic prosperity in the sense that rising wages indicate inflation is increasing.
The Fed is targeting an inflation rate of 2%, and take-home pay increased by 0.6% during the month of October. It is also now 4.6% up since October 2014. Not all metrics are positive however, since the manufacturing sector in the US has been hurt by a resurgent US dollar. Various measures have been adopted including running down inventories; cutting back on exploration, drilling and investment in the shale oil industry, and keeping costs on a short leash.

Please note that this column does not constitute financial advice.