Fed: Protecting the Pace

Published on November 6, 2015

Well, now that was some Nonfarm Payroll: wholly unexpected to be sure, but superlative across the board, the huge surge in jobs creation, upward revisions, the unemployment rate down to 5%, even a truly surprising jump in Average Hourly Earnings, and so on.


*** It goes without saying this morning’s jobs print is certain to further cement the Federal Open Market Committee consensus that was already tilting towards a first rate hike at its December 15-16 meeting (see SGH 10/28/15, “Fed: A Hawkish Tilt”). ***


*** With more certainty on that long awaited start to policy normalization, Fed messaging is likely to further accent what they believe will still be a likely gradual pace in slowly removing monetary accommodation through at least next year. ***


Two Questions on the Policy Path


There are perhaps two new questions that will be gathering in the markets over the Fed’s policy path, whether the higher wage growth might mean a more rapid pace of rate hikes, and whether a longer run of the dollar surge this morning will weigh against a first rate move in December.


That each is pointing in an opposite direction provides a clue to what we suspect will be a likely Fed communications fine tuning after today, namely, that both point to a reaffirmation of the likelihood for its projected gradual pace in the rate tightening trajectory, which as we have been writing, is a crucial cornerstone to the “sooner and slower” base case path long stressed by Chair Janet Yellen and supported by a clear Committee majority (see SGH 5/12/15, “Fed: A Hawkish Lift-off, Dovish Trajectory”).


First, while this morning’s NFP print is only one number as any right-minded Fed official will be quick to note — it could always be revised down and the pace of job creation is likely to revert back to a lower trend-line in the upcoming prints — it is nevertheless hard to argue that it doesn’t point to the “some” further removal of labor market slack. That is especially the case in that strong 0.4% AHE.


The Fed has been groping for “reasonable confidence” inflation will start moving back to mandate consistent levels of around 2%, and this should provide some welcome relief over the anxieties many Committee members felt over the no-show in higher wage growth up till now.


Monetary policy for one will still be highly accommodative during its first phase of nudging the policy rate higher, so the economy is likely to still run hot at near full employment through next year and that should mop up the remaining slack in the outer edges of the labor market.


But with the slack now mostly lurking in the corners of the discouraged, longer term unemployed, or the part timers seeking full-time employment, the number of net new jobs each month will almost by definition have to drop towards the break-even levels so many Fed officials have been accenting in recent weeks, more like 100,000 to at most 150,000 a month rather than today’s blow-out 271,000.


And that, in other words, should underpin higher wage growth next year (hello Mr. Phillips).


The Dollar’s Offsetting Effects


If anything, this upward trend on wages may be coming a little too early, and that, perhaps more than anything else, may set off a reversal in market anxieties from whether the Fed will ever be able or willing to raise rates to a pressing need to raise rates quickly to avoid being caught behind the proverbial curve.


But we suspect this is where the dollar trend may come into play in terms of how it shapes the base case policy path. Indeed, for all the market attention on what the dollar surge in the wake of the NFP print will mean for the Fed policy path, there are two things to keep in mind.


First, with the tail risk of a hard landing in China dissipating (see SGH 10/30/15, “China: New Targets and Limited Stimulus”), and Europe at least stabilizing, Fed officials find it hard to find a scenario of the dollar strengthening at anything like the pace it did earlier this year in the wake of the European Central Bank’s QE program. If there are any lingering doubts over next month, that will make it very hard to translate dollar strength into a hesitation for a first rate hike in December.


But second, and more importantly the track of the dollar does influence the likely pace of the Fed’s rate trajectory. The dollar effects are still more likely than not to slowly fall out of the inflation numbers through next year, but a modestly more resilient than expected dollar may in fact be desirable next year rather than feared, in two ways.


For one, it may help provide some extra exchange rate-driven stimulus to European and Japanese growth that will in turn help underpin US growth down the road. But second, and more to the point, Fed officials are likely to argue the US can afford any modestly stronger than expected dollar effects because it may in fact help to offset any potential faster than expected upward wage-driven pressure on inflation.


And Still, a Likely Gradual Pace


And that, we suspect Fed officials may soon message, only helps to ensure the gradual pace of the subsequent rate hikes, especially in its initial phase through next year.


So there is still much to digest in this morning’s weighty NFP print, and there is still plenty of data in that much repeated “data dependent” policy path between now and mid-December. But there would have to be one big, and unlikely, reversal in the direction of the economy and the jobs market after this morning to push the FOMC majority off the first rate hike in December.


Likewise, for now, we believe the Fed will still be stressing a most likely gradual pace in the rate hikes through next year. And perhaps this time, it will indeed be the best of all possible worlds after all.

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