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U.S. Payroll Report Provides Ammunition for December Rate Hike By the Fed

Friday’s nonfarm payroll report in the U.S. provided an “all clear” for the Federal Reserve to undertake the first rate hike since 2006. October’s job gains were the highest since January 2015, and were significant enough to bring the unemployment rate down to 5.0%. But the labor market picture has been improving for some time, so what makes us certain the Fed will hike at its December meeting? Both Chairwoman Yellen and Federal Reserve Bank of New York President William Dudley have indicate that a rate hike in December is a “live possibility;” here are three other reasons to expect a policy move.

Wages are rising. Average hourly earnings climbed by 2.5% year-over-year—the largest annual gain since 2009—while measures of slack are decidedly improved. The fraction of part-time employees working part-time due to economic reasons has fallen from a cycle high of 33% to 21%, while the median duration of unemployment has declined from 25.2 to 11.2 weeks. Wage growth (or the lack thereof) has been the missing piece in the unemployment rate decline puzzle. However, if the recent payroll report is any indication, wages across all job categories are increasing. Even in the lowest paid sectors—leisure/hospitality and retail trade—wage growth has been 2.5% or more over the past 12 months. And with zero headline inflation for September, real wage growth of 2.5% is meaningful.

Inflation is likely to stabilize. Heading into the new year, the drag on inflation from low oil prices is likely to dissipate. In September 2015, spot oil prices averaged $45.45/barrel, versus $93.22 in September 2014, making for a 51% decline. In January 2015, spot prices averaged $47.27, close to the $45/46 average in October and November. Will a stronger dollar continue to weigh on non-energy import prices? Yes. Even though the core PCE (Personal Consumption Expenditure) price index has not exceeded 1.3% on an annual basis this year, services price inflation (which has been at 1.8% or higher all year) will likely put a floor on any further energy-based declines.

Foreign financial markets have stabilized. Gone was the phrase “recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term” from the Fed’s last statement. Domestic equity markets are at record highs. China’s stock index is back in “bull market” territory as the country’s Securities Regulatory Commission just announced that a freeze in initial public offerings will end by the close of this year, suggesting markets have stabilized. The Fed can’t ignore activity abroad, but domestic growth appears strong enough to begin the process of rate normalization in 2015…even if the Fed stands pat during the first half of 2016.

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Heidi Learner

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