Why the Fed is likely to raise interest rates faster than you think
The US central bank may up the pace of interest rate rises next year. And that’s despite the fact President Trump just unveiled a pick for the next chair of the Federal Reserve who is already tied to its existing gradual approach, and despite Friday’s sub-forecast US non-farm payrolls number.
Jerome Powell, Trump’s preferred successor to incumbent chair Janet Yellen, certainly appears a strong supporter of the Fed’s current slow-but-steady rate increase policy. Powell, as US bank BNYMellon has pointed out, “has always voted with the majority, never once objecting in the 44 votes that he has cast.”
Perhaps it’s no wonder then that the UK’s Barclays Bank characterised the proposed change at the Fed as “Meet the new boss, mostly the same as the old boss.”
There’s also the issue that with Powell’s elevation there are still unfilled posts on the Fed’s board of governors, including that of vice-chair. There’s no guarantee that policy doves will be promoted.
Indeed, Stephen Chiu at China Construction Bank (Asia) in Hong Kong feels that “all in all, given that the upcoming voters are more likely to be hawkish than not, the 2018 FOMC set-up could be one of the most hawkish set-ups in recent years.” He was referring to the Federal Open Market Committee, that decides monetary policy.
Personalities aside, the Fed will continue to frame policy based on emerging US economic data.
And at first sight therefore, as Friday’s 261,000 non-farm payrolls rise in October was below economists’ forecasts of a 310,000 increase, there might seem little reason to expect an uptick in the pace of US rate rises.
But the devil is in the detail.
While the October headline payroll number did indeed rise by a disappointing 261,000, September’s figure was revised up to an increase of 18,000 from the initially reported 33,000 drop, and August’s moved to a 208,000 jump rather than 169,000. Those are upward revisions of 90,000 which, if added to Friday’s 261,000, produce a payrolls increase of 351,000 in total, which is actually above the consensus forecast.
Equally, the unchanged October US average hourly earnings, following a 0.5 per cent rise in September, should also be seen in context, given that the latter was hurricane-affected.
All this may help explain why, despite Friday’s apparent payrolls miss, based on a Reuters analysis of Fed funds futures traded on the Chicago Board of Trade, the market was still pricing in a 90 per cent chance of a December US rate increase and a 60 per cent possibility of another in June.
But that’s still arguably being conservative.
On Friday, following the US jobs data, JPMorgan raised its own forecast for the number of US interest rate rises next year to four from three. “In this environment we believe the Fed will see even more need for a steady, regular removal of accommodation,” the bank’s Michael Feroli wrote in a research note.
Others have been arguing for some time for a quicker pace of US rate increases than markets are currently expecting.
TS Lombard’s US Watch, penned on October 29 by their chief US economist Stephen Blitz and their head of strategy, Andrea Cicione, gave an evaluation of the direction of the US economy that should lead the Fed to “raise policy rates in December, March and June” pushing the Fed funds rate to 2 per cent.
Others, such as Europe’s Pictet Wealth Management (PWM) continue to believe that “US rate hikes will most probably remain on the slow track,” characterising Trump’s pick for Fed chair as “centrist to dovish.”
“Powell’s landing the role therefore leaves unchanged our monetary policy scenario, which foresees two 25 [basis point] hikes ahead (one in December, the other in March 2018),” PWM wrote on Friday while acknowledging that “the risk of a June rate hike is rising given recent stronger-than-expected [US] economic momentum.”
Friday’s release of data showing US service industries – which make up the largest part of the US economy – expanded in October at their quickest pace since August 2005, is certainly another mark in that stronger-than-expected column.
If the Trump administration also manages to get Congress to approve a tax plan that is perceived to provide a substantive stimulus to the US economy, the Fed would also have to take that into account.
Arguments that the markets are currently underestimating the pace at which the US central bank will raise rates in 2018 are rather persuasive.