The NFP report gave a little for everybody: weak headline number with 173K but positive revisions and annual wage growth rising to 2.2%. Also other factors are mixed: US data such as GDP looks good but the world looks weak, especially China.
So what will the Fed do? Perhaps go ahead but make it “the most dovish hike”. Here are 7 reasons to act in September, 4 potential sweeteners Yellen and her colleagues could offer to markets and a potential market reaction to such a scenario:
- Jobs are good: With a 5.1% unemployment, a zero interest rate seems inappropriate, even though the participation rate is low. Demographics, aka aging, are responsible for a big chunk in the fall in the participation rate.
- Inflation will come: Energy prices push headline inflation lower, but core inflation is OK. With a steady rise in wages, at 2.2%, core inflation will eventually come. It is important for the Fed to be ahead of the curve and not behind it.
- The US economy can absorb a 0.25% hike: The economic growth is not spectacular, but solid and steady enough. Another 0.25% will not make a big difference. The NFP report shows ongoing stability, also in a month that saw global volatility.
- Extreme preparation: The Fed has ended QE in October, urged patience and then removed forward guidance and left the door open. Everybody is expecting them to hike, so why not get over with it and end uncertainty.
- Not be bullied by markets: The Fed is criticized for working for Wall Street. If on every fall in stocks, which is part of the game, the Fed provides more stimulus, this becomes dangerous. Money flows into financial markets in expectations of central bank support, and not into the real economy.
- Show confidence: The Fed, especially under Yellen and Bernanke, has been very dovish. If a dovish Fed is raising the rates, it shows that it is confident in the US economy, and confident that the US could weather global headwinds. It would also be a sign of confidence for the whole world. The jobs report is good enough.
- Have another tool in the shed: Having the opportunity to cut the rates is something the Fed doesn’t have now. In order to regain this tool, it should take the opportunity it has now, after the OK report and regain it if things move away from the current stability.
But with this hike, the Fed could also wrap it up with a lot of candy, to ease the reaction.
4 possible sweeteners
- Data dependency: Yellen could remind everybody listening to the press conference that the Fed remains data dependent, and that any future move will depend on improvement.
- Signal this the only hike for 2015: This cannot be said directly because the Fed is data dependent, but hinting that this is a one off move, at least for the upcoming month, will sooth markets.
- Remind us about the balance sheet: The Fed ended QE back in October 2014. This means it stopped creating new money and stopped expanding its balance sheet, but it never squeezed it. So, the Fed continues buying a new bond for any bond that matures. The balance sheet remains bloated. The Fed could remind us that this stimulus is not going away anytime soon.
- Say that the Fed will closely monitor the impact: By giving special attention to markets, the Fed could also smooth the reaction.
If this scenario of a “dovish rate hike” materializes, we could see spike in the dollar (as a hike is far from being priced in) but with a slide in the dollar later on, as more certainty comes to the markets as they understand the world hasn’t ended.
What do you think?
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