U.S. Data Green Lights Fed for December Rate Hike
After a weak first half of the year, third quarter real GDP growth improved to a 2.9 percent annualized rate. The inventory sell-off that weighed heavily on GDP growth in H1 looks like it is reversing in late 2016 and should contribute to above-potential growth over the next few quarters. Payroll job growth in the third quarter was strong, averaging 206,000 net new jobs per month and the unemployment rate averaged 4.9 percent. The October employment data suggests that job growth is stepping down a little; only 161,000 jobs were added for the month. But that was enough to tighten the unemployment rate back to 4.9 percent. We look for the unemployment rate to bottom out somewhere around 4.6 to 4.7 percent in this cycle. Labor markets across the country are tightening and wages are going up, including some by mandate as minimum wage legislation in several states complements raises already granted by some major employers. Average hourly earnings increased by 0.4 percent in October and were up by 2.8 percent over the previous 12 months. With wages heading up, energy prices moving up, house prices and rents going up and medical costs still increasing, there is a whiff of inflation in the air. The September Consumer Price Index increased by 0.3 percent for the month, and was up 1.5 percent over the previous 12 months. We expect headline inflation indicators to continue to warm up through early next year.
At the recent Federal Open Market Committee meeting of November 1-2, the Fed did exactly as expected by not raising the fed funds rate while hinting that a rate hike at their next meeting, over December 13-14, is a strong possibility. According to the November 2 press release, the FOMC “judges that the case for an increase in the federal funds rate has continued to strengthen but decided, for the time being, to wait for some further evidence of continued progress towards its objectives.” They received more evidence with the October jobs report, and we expect them to get even more evidence of tightening labor market conditions and increasing wage pressure with the release of the November jobs report on December 2. The implied probability of a fed funds rate hike is now about 76 percent according to the fed funds futures market. Expectations are set and the door is open for the Fed. All that is needed is another month of benign economic data. We also see hints that other central banks are expecting more inflation and preparing for eventual monetary policy tightening. The Bank of England modified its forward guidance in its Monetary Policy Summary of November 3, effectively taking another interest rate cut off the table. Likewise, the Bank of Japan refrained from adding more stimulus in their monetary policy statement of November 1.
The U.S. general election, and its aftermath, is still potentially market moving. The slide in major equity indexes, that began in September, accelerated through October. Solid Q3 GDP data and expectations for a repeat in Q4 are supportive of equities, but election uncertainty is high and anxiety about the aftermath of the election, on both sides of the political aisle, also appears to be high. This is obviously not a normal election, and so the expectation of a post-election bounce in equities that spills over into a generalized consumer bliss needs to be discounted. Still, we expect to see a well performing economy after the election and ongoing economic momentum through 2017.
For a PDF version of the complete Comerica U.S. Monthly with additional commentary, tables, and charts, click here: USEconomicOutlook1116.