Friday’s US jobs reports posted strong numbers overall, with the average monthly jobs gaining 271k, beating a conservative estimate of 181k average. The monthly unemployment rate also dipped a tick lower to 5.0%, indicating full employment, which means that the Federal Reserve has met one of its two mandates (full employment and inflation or price stability being the other mandate). While inflation is still a concern, the October jobs report no doubt signal the fact that December could very well be the month when the Fed is certain to hike interest rates, marking a recovery in the economy which was hurt after the 2008 global financial crisis.
It is therefore prudent now to focus on the ‘pace’ of the rate hikes. December expectations are for a 25 bps rate hike, to bring the US Federal Funds rate to 0.50%.
The Fed has been communicative in noting that the pace of the rate hikes will be gradual, meaning that the rate hikes decisions going forward would depend on the unfolding economic data from the US. For the most part, once the Fed starts to tighten monetary policy, almost every following FOMC meeting is likely to gain a lot of attention with the markets focused on whether the Fed will hike further or stay put.
An interesting factor to bear in mind is the first quarter of the US which is historically known to be the weakest seasonally. Therefore, while the markets can now fairly expect a rate hike in December, it is unlikely that we will see further hikes during Q1, unless the Fed is convinced that the US economy can recover off the seasonal economic weakness. To make matters critical, this will be the first in a long time that the Q1 weakness will also need to deal with tighter monetary conditions.
What to expect as we approach the December rate hike?
The US Dollar is likely to gain in the run up to the rate hikes while commodities will remain subdued or at best range sideways. However, once the Fed starts its tightening cycle, commodities are likely to gain while the US Dollar could come under pressure. Gold, often known as a speculative bet against inflation is likely to gain but this could only come after a new low is posted in the markets.
For the moment, the markets are starting to price in the December rate hike and the US Dollar is likely to remain well supported. The Fed’s view is unlikely to change unless the equity markets start to post strong declines in the run up to a monetary policy tightening cycle.
Most of the other Central banks will most likely stay on the sidelines, as we witnessed over the past month with the BoC, BoJ, BoE and the RBA holding back from making any further monetary policy changes. A certainty in the Federal Reserve rate hike could also potentially keep the ECB from acting in December as interest rates and monetary policy divergence should be enough to keep the Euro subdued.
Looking forward, focus will be on the inflation numbers and of course the November jobs report which would take a ‘worst’ print to question the rate hike decision.
