Stages of grief as US interest rate increases loom
With the payroll numbers pointing to a September Fed rate rise, investors appear to have moved into a new stage of their grief over losing zero interest rates.
Before there was denial - "They’ll probably even wait until 2016, because China and Greece, and emerging markets, and ... and ... and China."
Now, along with a dollop of anger, we get bargaining - "Sure, they will raise interest rates but only once this year and maybe not eventually very high at all."
If the market continues to follow the Kubler-Ross model of five emotional stages during a significant loss we can expect next up to be depression.
That is when risk asset markets drop sharply. Then comes acceptance, which we should remember is healthier than the previous four but does not imply a rally.
Friday’s US nonfarm payrolls report was solid, if not spectacular, showing an economy that continues to create jobs at a recovery pace, one which should, ultimately, drive wages north alongside.
The economy gained 215,000 jobs in July, with net upward revisions of another 14,000 to the two previous months and a small increase in earnings growth.
Unemployment remained at 5.3 per cent, doing nothing to upset the Federal Reserve’s forecasts for the final three months of the year.
Having said at its July rate-setting meeting that employment was "solid" and that the US central bank was looking for a bit of travel in the same direction before raising rates, this report leaves the Fed with less plausible pretext than before to delay.
Markets, at last, got the message, and now price a September rate hike at about a 59 per cent probability.
October fed funds futures, which allow investors to bet on where interest rates will be after a given Federal Open Market Committee meeting, rose 2.5 basis points on the day but contracts further out are not showing nervousness about a steep trajectory for rates.
"Our major takeaway is that the muted market reaction is because asset markets are treating the higher September lift-off probability as a one-off shift on timing, rather than as an indication that the Fed is going faster and further," strategist Steven Englander at Citigroup wrote to clients.
"Increasingly, it looks as if the debate will shift to one versus two hikes this year, but so far the market view is that September is more in, but the risks on subsequent FOMC meetings are unclear."
That reasoning, that the Fed would like to get it over with in September but that it is unlikely to be shifting its fundamental analysis of where a natural rate of interest will be in six months or a year, is reassuring.
It’s also, at least based on history, unlikely to come true.
As Fathom Consulting point out, a typical Fed hike campaign lasts two or three years and goes upward at a pace of about 200 basis points per year.
That’s four times what the market is now discounting, or should we say bargaining on.
The speed of adjustment also depends in part on the starting point in terms of real interest rates, according to Fathom.
With a real rate today of about negative 1 per cent, we would typically see a faster adjustment rather than a slower one.
To be sure, there is much which has changed in both the global and the US economy, and this time may be very markedly different.
The S&P 500 fell after the data, trading about 0.7 per cent down on the day, and about 4.5 per cent lower than its mid-July highs.
That kind of gentle downward slope is consistent with a market which thinks it can bargain its way to a gentle rise in rates. Any taste of something sharper, and bargaining gives way to depression.
Today’s investor is probably best treated with sympathy and compassion, but also a good deal of caution.
Consider that for many the possibility that the Federal Reserve could do something that might impair the value of their financial assets is unfathomable.
Many younger investors will never have even gone through an upward interest-rate cycle at all.
The bargaining stage, like the denial stage, may go on for longer than the evidence suggests it should.