Digest Dec 2015 No7 : A day after The Fed's decision to raise the rate
Fed policy normalization journey beginning
- The Fed's decision to raise its target interest rate by 25 basis points in December was a function of both the strength in the labour market and the anticipation that inflation will slowly move back to target. However, while rates have moved off the zero lower bound, this will not be a run-of-the-mill rate hike cycle. Rates are likely to rise by only 75 basis points (to 1.25%) by the end of 2016 and to 1.75% by the end of 2017. The average increase in past rate-hike cycles was roughly 200 basis points within the first year.
- The go-slow approach reflects the need for the economy to grow above trend in order absorb the remaining slack in the labour market, as well as the disinflationary impulse from an improving, but still generally sluggish, global growth environment.
- It also reflects the fact that the terminal level for the policy rate is much lower than it has been historically. While the last rate hike cycle saw rates rise to 5.25%, this cycle is likely to end within a range of 3.00% to 3.25%. However, that level probably won't be attained until 2019.
US inflation will edge higher
- The result of falling energy prices and a rising dollar has been the disappearance of inflation. The next year is likely to see a partial unwinding of these influences. Falling energy prices cut 1.7 percentage points from inflation over the past year. Oil prices are unlikely to return to their former level, but a slow recovery will still add 0.8 percentage points to inflation over the next year. Likewise, the high dollar has cut about 0.4 percentage points from both core and headline inflation. This influence will partially reverse over the course of 2016.
"We expect CPI inflation to rise to 3.0% by the first quarter of 2017, before heading lower as these re-inflationary forces wane", notes TD Economics.
- The final element to pull inflation higher is the tightening labour market. The unemployment rate is expected to fall below 5.0% - a level that is consistent with stable inflation. As it does, it will add to the pressure on wages, which are already displaying a broadening pattern of
sturdiness across industries.
- Analysis at the regional level indicates that weakened wage growth within oil producing states has depressed the national level since mid-2014. However, a distinct upward trend is evident among the oil-consuming states, which represent the majority of the U.S. landscape.
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Dollar to stay lofty, but another leg up is unlikely
- The rising dollar was the other headwind to growth over the past year. The greenback's ascent did not begin in 2015, but it continued at full steam. From the start of the year to December, it rose 9%, the same rate of increase as 2014. This, combined with a slowdown in global economic growth, hit exporters.
- Foreign GDP growth in 2015 fell to its slowest pace since 2008 and, unsurprisingly, exports virtually stalled. Imports, on the other hand continued to advance, supported by the increased purchasing power of the dollar and the strength in domestic spending. Consequently, net exports shaved 0.6 percentage points from growth in 2015.
- The highflying greenback will continue to bite into exports over the course of 2016. But, the potential for another leg-up looks limited given that financial markets have largely priced in policy divergence with the U.S. relative to its peers. In addition, the global differential in economic growth is likely to diminish. Emerging markets will continue to be challenged, but the process of adjustment, especially for commodity exporters, is already well on its way.
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December US job growth: the gift that keeps on giving
- For the December employment report, scheduled for release on Friday, January 8, nonfarm payrolls are expected to have risen by 225k. Within this, private payrolls are expected to have expanded by 215k and government payrolls to have grown 10k. Initial jobless claims were nearly unchanged from the November to December reference week (271k versus 270k). While continuing unemployment claims are currently higher than one month ago, it is believed that this uptick reflects seasonal volatility. The unemployment rate is expected to fall one-tenth to 4.9% (previous: 5.046%), and average hourly earnings to rise 0.2% m/m (2.8% y/y). Finally, expect a steady workweek at 34.5 hours.
"On balance, we view payroll growth as back in line with its underlying trend of 200-225k", says Barclays.
- A similar rate of job growth over the next few quarters should push the unemployment rate lower and lead to further tightening in labor markets, keeping the Fed on course for a gradual pace of tightening of about 75bp in rate increases per year.
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US December non farm pay rolls likely to rise
- US December employment report is likely to show a rise. Initial jobless claims were approximately steady from November to December reference week. While continuous unemployment claims are currently higher than previous month, this upward movement indicates seasonal volatility.
"we forecast nonfarm payrolls to have risen by 225k. Within this, we expect private payrolls to have expanded by 215k and government payrolls to have grown 10k,the unemployment rate to fall one-tenth to 4.9% (previous: 5.046%), and average hourly earnings to rise 0.2% m/m (2.8% y/y). Finally, we look for a steady workweek at 34.5 hours", says Barclays in a research note.
- The payroll growth looks consistent with the underlying trend of 200-225K. If the job growth continues in a similar pace, it will push unemployment rate lower and lead to labor market tightening, keeping Fed on track for further rate-hikes next year.
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U.S. likely to see moderate GDP growth ahead
- The Conference Board's Leading Economic Index in United States increased by 0.4% month on month in November. At a disaggregate level, building permits increased by 0.3PP, stock prices, interest rate spreads and credit conditions each increased by 0.1PP. These were the main driving factors of the index for November.
- In contrast, initial jobless claims and ISM new orders inclined the growth rate of the index. Initial jobless claims reduced by 0.1pp and ISM new orders reduced by 0.1pp.
"The two-month rebound in the LEI provides little new signal on the direction of the US economy, other than confirming our outlook for continued moderate GDP growth", states Barclays in a research note.
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