US Rate Rise back on Centre Stage

The US Federal Reserve will step back on to centre stage this month with everyone wanting to know whether they’ll hike rates in December. The market had only given a 35 per cent chance to a December rise but this flipped dramatically to 70 per cent when the latest US employment report was released.

The game changing report was strong in all aspects – the unemployment rate, the number of new jobs and a fall in the under-employed rate to less than 10 per cent. Most importantly, there was a strong increase in wage growth – 2.5 per cent – the strongest annual wage growth since mid-2009.

Wage growth is a proxy for inflation so the Fed will view this as inflationary pressure and it will give them more comfort to raise rates. Wage growth also means US employees are getting richer. If the Fed doesn’t raise rates now and quicker than expected, the increase in wealth will be saved and not spent. And the US needs it to be spent to keep momentum going in the economy.

Of course, there is still one more employment number due out before the December meeting so it’s not a given that rates will be hiked.

Markets respond

The response to the latest jobs report from the foreign exchange and fixed income markets was exactly as expected. The US Dollar strengthened against all currencies and bond yields rallied.

The reaction from equity markets, however, was harder to predict. Overall, they’ve been pretty quiet which speaks to equity resilience. This is also consistent with the view that the market was much more fearful of the opaque China policy than it was about the Fed. But with fear about China abating, the Fed’s decision will again dominate the market.

Another thing to keep in mind is that so far this year the markets have followed seasonal expectations – rally into Feb, sell in May etc etc. If the trends hold true, we should therefore see the Christmas rally beginning in mid-November.

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