Did the U.S. Federal Reserve Just Tell Markets That It Would Raise Rates in December?November 2, 2015
Why a U.S. Fed Rate Rise in December Is Still Not GuaranteedNovember 16, 2015
The latest employment data for both Canada and the U.S. came in much higher than expected last Friday. The futures market quickly raised the odds to 75% that the U.S. Federal Reserve will hike rates at its December meeting, and bond yields on both sides of the 49th parallel surged higher in sympathy. Canadian mortgage lenders wasted no time in raising their fixed mortgage rates.
This is exactly the type of volatility that I warned about in last week’s post. The Fed’s revised wording in its latest policy statement had indicated that it was poised to raise its policy rate at its next meeting if the U.S. economic data continued to show encouraging signs. The biggest X factor in that data was U.S. employment momentum which had stalled over the previous two months after showing impressive strength over the prior twelve months. Markets reacted quickly to the upside surprise.
Here are the highlights from the U.S. non-farm payroll report for October:
- Overall U.S. employment surged by 271,000 new jobs, well above the consensus forecast of 185,000.
- In another bullish signal, average hours worked rose by 0.3% for the month.
- The U.S. employment gains were broadly based. There was notable growth in construction, which added 31,000 new jobs and served as a further vote of confidence to the U.S. real estate recovery, and in retail, which added 44,000 new jobs and was a bullish signal for the upcoming holiday-shopping season.
- Average hourly earnings rose by 0.4% in October and have now risen by 2.5% on a year-over-year basis. This key signal provides evidence that tighter U.S. labour-market conditions may finally be starting to push wages materially higher. For now, the purchasing power of the average American consumer is expanding because average wage growth is outpacing average inflation growth, but continued wage growth could lead to pervasive inflation, which has the potential to spiral. But after grappling with sluggish growth and the threat of deflation for years, the Fed would rather err towards the risk of too much inflation, which it has well-worn tools to deal with, than towards the risk of deflation, which is a far more difficult beast for the Fed to tame.
While a Fed rate hike in December now seems likely, we will see one more months’ worth of U.S. employment data before their next meeting and there are plenty of other moving parts that could impact the Fed’s overall assessment of market conditions between now and then.
For example, expectations of an imminent U.S. rate hike are fuelling another surge in the U.S. dollar, which has impacts both at home and abroad. The surging Greenback has already created a headwind for the U.S. economy that is equivalent to about 100 basis points worth of Fed rate increases. If the U.S. dollar surges again, it will continue to do much of the heavy lifting for the Fed and will reduce the need for monetary-policy tightening. Furthermore, the Fed held off on raising its policy rate at its September meeting in part because of concerns about economic instability beyond its borders. Another U.S. dollar surge could fuel rising instability in emerging markets, thus exacerbating the Fed’s previous concerns.
While it appears increasingly likely that the Fed will raise its policy rate in December, if we’ve learned anything since 2008, it is that central banks take a lot longer to hike rates than we (or they) think they will, and that’s why I continue to believe that the Fed’s next rate decision is not yet a forgone conclusion.
While the Canadian employment data didn’t garner nearly as much ink, our labour market had a good month in October as well. Here were the highlights from the latest Statistics Canada report:
- Our economy created 44,000 new jobs last month, which was well in excess of the 10,000 new jobs that the consensus was expecting. We have now averaged about 21,000 new jobs/month over past six months, and this keeps us slightly ahead of the 20,000 or so new jobs that we need in order to keep pace with our population growth.
- Most of the gains were in part-time employment which rose by 35,400 new jobs (with much of that increase being attributed to our federal election), but our economy also created 9,000 full-time jobs which represented almost as many jobs as were expected overall. While it is true that most of last month’s gains were in part-time jobs, our full-time job growth/month has averaged 13,000 over the past six months while our average part-time job growth has averaged 9,000/month over the same period, so full-time/part-time job-creation comparisons are still favourable when smoothed out over a longer period.
- Average hours worked rose by 0.3% in October, signaling a small increase in the demand for existing labour over that period, but this followed a drop of 0.8% in hours worked in September, so we only recovered part of the prior month’s drop.
- Conversely, while average wages fell by 0.3% in October, this was after they surged 1.4% higher in September, so the giveback was not unexpected, and this drop was likely exacerbated by last month’s rise in part-time employment demand. Average wage inflation over the most recent twelve months is still running at a very healthy 3.1% so Canadian consumers are enjoying a rise in their purchasing power as we head into the holiday season, an encouraging sign for our retailers.
- Manufacturing employment rose by 6,500 new jobs last month and that development is as an encouraging sign that the Loonie’s fall against the Greenback is helping this beleaguered sector. If this trend continues, our policy makers hope that it will fuel the rise in business investment that they believe is so essential to any sustainable-recovery scenarios.
Five-year Government of Canada bond yields rose fifteen basis points last week, closing at 1.03% on Friday. Five-year fixed-mortgage rates rose across the board and are now available in 2.54% to 2.69% range. Not every lender raised by the same amount, so there a little more variance in offered rates than usual at the moment (making it a good time to shop around). Five-year pre-approval rates are now available at 2.74%.
While not directly driven by last week’s strong employment reports, five-year variable-rate discounts also shrank last week and are now being offered in the prime minus 0.60% to prime minus 0.50% range.
The Bottom Line: The latest Canadian employment data should take any prospects of another Bank of Canada (BoC) rate drop off the table, but not to the point of pushing the Bank into rate-hike territory. For now, it’s steady-as-she goes for the BoC while we wait and see whether our neighbours south of the border finally pull the trigger on their first rate increase in nearly a decade.