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Fed’s December policy meeting, is another rate hike inevitable?

The US Fed kept the benchmark Fed fund rate in the range of 0.25%-0.50%, this was announced in the monetary policy meeting in September 2016. The agency stated through the policy statement and a press conference that the economy will continue to see the growth. The central bank moderately reduced its expectations on the long-term economic and inflation growth, but it was positive on the developments in the labour market and the overall health of the economy. However, there was also a less talked policy meet in November, the broader policy continued in line with the September announcements. The focus is now on the 2-day policy meeting in December, which too like September would have a post-policy press conference, that is why there is so much interest in the development.

The last time the Fed raised its interest rate by 25 bps (basis points) in December 2015, the action is largely expected to continue with around 2 to 4 successive hike in 2016. However, the case for a rate increase loosened amidst weakening economic cues in the US during the first half coupled with little political and economic upheavals in the European region, such as the Brexit. Lately, the state of the US economy is portraying optimism through major economic signals.

Herein, Televisory would like to state that the employment situation and the inflation growth are two of the critical factors which the Fed takes into consideration during its policy decisions. The latest non-farm payrolls report from the BLS (Bureau of Labor Statistics, US) shows that the economy in November payroll recorded a healthy increase in the jobs by 178,000. In the past 3 months, the job addition in the US averaged 175,000 per month, whereas in the first 11 months of 2016 the average monthly increase was in 180,000. As per the broader consensus in the US, an addition of over and above 150,000 jobs indicates a stable to positive growth in the labour market. Furthermore, average hourly earnings grew by 2.5% on a YoY comparison, marginally lower than 2.8% marked in October data, though this overall depicted steadiness. Likewise, the unemployment rate dipped to 4.6%, averaging around its best level from 2007.

 

Source: Bloomberg Data and Televisory’s Research

Although the total labour participation continued to hover below the 63% mark, nearing its multi-decadal low, the size of the total workforce in the US increased by a decent margin in the past couple of years making the figures less negative. This was supported by the jobless and continuing claims data, which lately registered a persistent contraction. The jobless and continuing claims numbers slipped down by ~28% and ~35% in the last 5 years with the recent figure nearing ~250,000 and ~2 million respectively. This was the lowest level of jobless claims in over a four-decade period while it is the lowest for continuing claims since 2000.

 

Source: Bloomberg Data and Televisory’s Research

A look at the inflation data reveals that the CPI and PPI numbers saw a reasonable improvement over the last couple of months. CPI on a YoY comparison grew by 1.6% during October, while this has gained almost every month since July 2016. Over the past 3 months, the YoY CPI growth averaged 1.4% which is sharply higher than the average rise of 1% in the first 7 months of 2016. The less volatile, core CPI figure (Excl. food and energy costs) was maintained over the 2% mark throughout 2016. Further, the PPI data which was in negative in the past 22 months has moved into the green territory during October 2016. PPI increased by 0.6% on YoY comparison in October and gave a healthy sign that the negative effects of falling commodity prices (energy, metals and agriculture) were eased as most records stabilised. 

 

Source: Bloomberg Data and Televisory’s Research

The other indicators such as manufacturing, services, housing and construction activity also picked up. The overall positive impact was also be seen in the Q3 GDP data, which grew by 2.9%, a strong increase in comparison to the average 1% growth was seen in the last 3 quarters. Q3 growth was driven by increasing inventory figures along with better trade data for the US. Though consumer spending was a drag on the business investment, increasing inventory levels marks a positive sentiment for wholesalers, who expected demand to pick up in the last quarter.

 

Source: Bloomberg Data and Televisory’s Research

 

Source: Bloomberg Data and Televisory’s Research

The signals of economic strengthening from the US are raising market’s expectations that a hike in the December meeting is almost certain. A survey from the Bloomberg divulges a near 98% probability that the Fed would increase interest rates by 0.25% from the current target range of 0.25%-0.5%. The Fed Chair in its recent testimony in front of the US Congress reiterated its stance on the employment and inflation in the country. Tracking the movement in the US dot plot, the median forecast for the Fed members predicts an interest rate ranging from 0.5% to 0.75% by the end of 2016. The dot plot reflects near to long-term projections of the interest rates by the Fed committee members, hence, with only one meeting left, it is becoming evident that the rate hike will apparently happen.

This is further strengthened by the comments of Donald Trump, the US President-elect, who wants a fiscal stimulus in the economy and is also proposing tax reforms. Trump’s statements have also raised inflation expectations in 2017, this has also impacted the equity, currency and bonds market performance in the US and the world. Over the last couple of weeks, there is an uptick in the US government bond yields (30 Yr., 10 Yr., 5 Yr. and 2 Yr.) while equity markets are enthusiastic over an expected stimulus boost. Thus, as rate increase gets digested in the markets, emerging market currencies, equities and bonds are falling while a positive effect could be seen in the US Dollar index. Investors are divesting money from risky assets and banking on the safe USD and even ignoring gold. In the present scenario, a rate hike looks imminent, although more than this, market participants would be interested in a number of rate hikes in 2017 and in the future. The Fed’s decisions would be closely watched and how it maps the future policy amidst economic and monetary policy developments in Europe, Japan and stagnant economic growth in China. The market seems to have factored in a moderate increase in interest rate, and therefore, any increase that is higher than 0.25% or postponement of the rate increase will likely bring in volatility in various asset classes in the market.

Source: Bloomberg Data

                Note: Data for the week ending on 9th Dec. is taken up-to 8th closing

 

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