As the U.S. Federal Reserve debates withdrawing accommodation the doves have the upper hand, but that does not mean they won’t make a concession to hawks and hike sooner than the market expects.
The S&P 500 Index closed 0.5 percent higher at a record 2,007 on Friday, despite somewhat tepid August payroll gains of just 142,000 jobs, which did little to temper enthusiasm among U.S. equity bulls.
Personally, I don’t make much of the below-expectations increase in payrolls, as that number is subject to significant revision. However, with wage growth low and payroll growth subdued, the more dovish members of the Federal Open Markets Committee will certainly have increased ammunition for keeping interest rates low when they head into their September 16-17 meeting.
Even though August’s labor force participation rate was slightly lower than July’s, the overall downward trend has been broken. As a result, the rapid decline in the nation’s unemployment rate should begin to slow, which could put the timing of arriving at the non-accelerating inflation rate of unemployment, or NAIRU, later than currently expected. As unemployment and the rate of wage growth are two critical components in any move by the Federal Reserve to withdraw monetary accommodation, the doves clearly have the upper hand for now.
Meanwhile, polls about the upcoming Scottish referendum have tipped for the first time this year on the side of Scottish independence from the United Kingdom. That, coupled with European Central Bank President Mario Draghi’s announcement last week regarding quantitative easing in Europe, has prompted a drop in the value of the British pound and the euro, strengthening the U.S. dollar significantly.
This will further dampen U.S. inflationary pressures by reducing input prices and costs of imports just in time for Christmas. This should further buoy bond prices as inflationary expectations remain contained, which in turn would support more accommodation by the doves.
Nevertheless, the doves are sensitive to unity and may want to be seen as flexible to changing conditions. They may feel a need to make a concession to hawks by either changing the language of the FOMC statement or by indicating a willingness to modestly increase rates sooner than the market anticipates.
However, this should not necessarily be interpreted as a bearish indication for markets since the broader downward pressures on interest rates remain intact and stocks tend to continue rising even after a rate hike as investors take the withdrawal of accommodation as an endorsement of the sustainability of the economic expansion.
For now, the bulls hold the advantage.
Participation Data May Extend Low Rates
The U.S. unemployment rate has been falling at near its fastest pace in 30 years, but the decline is largely due to the millions of Americans who dropped out of the labor force altogether due to poor job prospects. This has left Federal Reserve Chair Janet Yellen reluctant to raise interest rates, even though the unemployment rate is relatively low. Recently, however, the decline in labor force participation has stabilized. As more people re-enter the workforce and look for jobs, they will be counted as "unemployed." This should slow the decline in the unemployment rate and suggests Dr. Yellen may keep rates low for longer than previously anticipated.
CHANGE IN UNEMPLOYMENT RATE AND LABOR FORCE PARTICIPATION RATE
Source: Haver, Guggenheim Investments. Data as of 9/10/2014.
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