U.S. Bond Market Week In Review: A Rate Hike Is In The Cards, Edition

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Numerous Fed Governors have correctly observed that both unemployment and inflation levels support a rate hike. Unemployment is 4.6%, core CPI is 2.1%, while total CPI is 1.6%. But an ancillary question all Fed governors must answer is, "Can the economy absorb an interest rate increase?" Granted, a 25 basis point hike from the 50 basis point (bp) level will probably not lead to a recession. But the economy must be strong enough to absorb a rate increase. The latest Beige Book contains sufficient information to show the economy is strong enough to absorb a 25 basis point hike.

Demand for manufactured products was mixed during the current reporting period, with the strong dollar being cited as a headwind to more robust demand in a few Districts. Modest to moderate increases in capital investment are expected in several other Districts. Business service firms saw rising activity, especially for high-tech and information technology services. Reports from ground freight carriers were mixed, while port cargo increased. A majority of Districts reported higher retail sales, especially for apparel and furniture. New motor vehicle sales declined in most Districts, with a few Districts noting a shift in demand toward used vehicles. Tourism was mostly positive relative to year-ago levels. Residential real estate activity improved across most Districts. Single-family construction starts were higher in a majority of Districts, while multifamily construction reports were mixed. Activity in nonresidential real estate expanded in many Districts. Banking conditions were largely stable, with some improvement seen in loan demand. Farmers across reporting Districts were generally satisfied with this year's harvests. However, low commodity prices continue to weigh on farm income. Investment in oil and gas drilling increased slightly, while reports on coal production were mixed. A tightening in labor market conditions was reported by seven Districts, with modest employment growth on balance. Districts noted slight upward pressure on overall prices.

The overall economy is growing strongly; the latest 3Q GDP report pegged growth are 3.2% - a solid rate. The manufacturing sector is performing well. The latest ISM readings was 53.2; the report contained unanimous anecdotal information showing positive activity in numerous industries. The latest durable goods orders rose 4.9%, rising 1% ex-transports. Turning to the service sector, we also see a solid expansion. The latest ISM services index reading was 54.8. And the US consumer, who is responsible for 70% of US growth, is still spending at solid rates. Recent personal income and spending data from the BEA showed solid gains in durable goods and services purchases. Additionally, recent retail sales numbers have been strong. Housing sales are continuing to grow - although the recent rate increases may slow future growth. And finally, the unemployment rate is very low, indicating the labor market is tight. All of these factors show an economy that is more than capable of handling a rate increase.

At this point, a December rate hike is all but a certainty.

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