The market response to the latest jobs report is almost comical. Not the response of U.S. stock prices (NYSEARCA:SPY), as the surge higher for the day is certainly more than expected. Instead, what was truly ridiculous was the latest shift in the market expectations for interest rate policy from the U.S. Federal Reserve. One can only hope that monetary policy makers themselves are not so capricious. But I have my doubts.
Remember those wild times from so long ago when the market was convinced because conditions had supposedly improved so much that we would see another interest rate increase in July? Or how about that era where the employment situation appeared far worse than expected and the prospect for any rate hikes from the Fed was completely off the table? Or how about that period when a tectonic shift was taking place across the European economy that would result in no interest rate increases until at least a year and a half from now in 2018? Remember all of those times in the past that are so different than today where we are entertaining the idea of a Fed rate increase as soon as two months from now in September?
What a contrast we have seen over the years. Except, of course, that it has not been years where we have seen such major changes in views on monetary policy. Instead, these are the wild ping-pong swings that we have seen in the expectations for monetary policy over the past seven weeks.
That's right, in less than 50 calendar days including weekends and holidays, we've gone from the market assigning a meaningful probability for a rate hike in July to a low possibility of a rate hike in December to virtually no chance for an interest rate hike until 2018 along with the possibility for a rate cut to all the way back to once again entertaining the idea of a rate hike in September. I'm feeling dizzy just writing about these wild spins over such a short-term period of time.
Whimsical Monetary Policy
Of course, we can count on monetary policy makers at the U.S. Federal Reserve to show more discipline, right? After all, these are the academic experts that maintain a cool hand to see us through the short-term noise and smooth out the data to keep the overall policy plan on course, right? I respect the challenging tasks that those at the U.S. Federal Reserve have been assigned to fulfill, but I do have my concerns about their susceptibility to the same emotional swings exhibited by the broader investing world, particularly given how sensitive they have become to the direction of stock prices on any given trading day.
Such concerns about capriciousness at the Fed were reinforced once again today following the lightening fast report by Jon Hilsenrath at The Wall Street Journal in the immediate aftermath of Friday's jobs report. It should be noted that Hilsenrath isn't just your everyday average reporter. Instead, he is the reporter at the The Wall Street Journal that is known to have particularly good sources for insights at the Fed. The headline of the article basically says it all:
"June Jobs Report Raises Chances of Fed Rate Increase in September"
Never mind that these monthly employment reports are notoriously unpredictable and subject to significant revisions over time. Never mind that Friday's strong report came on the heels of May's equally lousy report. Never mind that today's report says nothing about what the jobs report in July or August might bring. And never mind that it is just a single data point and not a trend that has evolved over time. It was a good jobs report on Friday, thus the chances of a Fed rate increase in September is now higher.
One can only hope that the Fed's thinking about the greater chance of a rate increase in September is at the margin. But regardless of what the Fed may think today, I'm willing to bet that by the time we are awaiting the Fed's post meeting press conference on the afternoon of Wednesday, September 21, the odds of a Fed interest rate increase will be back to zero. But that's just one person's view.
So Where Do We Stand Today?
Although like most people's underwear they will probably be different come tomorrow, the following is where the market currently stands with its interest rate expectations for the U.S. Federal Reserve.
Coming into Friday's employment report, the market according to the CME Group 30-day Fed Fund futures was assigning a 0% probability for a 25 basis point increase in interest rates through November 2016. At the same time, a slight 3.6% probability existed for a 25 basis point cut over this same time period. In other words, the market saw absolutely no chance for a Fed rate hike for several months.
But following the release of the June employment report on Friday, the probability for a Fed interest rate cut fell back to 0% while the odds for a Fed rate hike increased to 12%. The same can be said for November, although it is almost impossible to envision the Fed raising interest rates a mere six days before the general election in November, particularly since there is no press conference following this meeting. As for December, the probability for a 25 basis point increase in interest rates has increased to 26.5%, including a 2.3% probability for 50 basis points worth of rate hikes having been achieved by then.
Interestingly, the odds for any further interest rate increases beyond December 2016 are virtually nil, as the current probability for a 25 basis point increase in interest rates by June 2017 is nearly the same at 32.7% as it is in December 2016.
The Bottom Line
The latest monthly employment report, as flawed as it may be, has entered us into our newest chapter of interest rate expectations for the U.S. Federal Reserve. Any expectations for a Fed rate cut are now back off the table. And the probability for one 25 basis point increase by the U.S. Federal Reserve over the next twelve months has increased from about one-in-six or five to roughly one-in-four or three.
For those that are optimistic about the global economic outlook, this is a reassuring shift.
And for those who believe there is no chance that the Fed will be raising interest rates anytime soon, these higher probabilities have the potential to bring back to earth at least to some degree the price of those securities that are expected to perform best in an otherwise slowing global growth environment.
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