Monthly Archives: November 2015

Macro Focus – ZIRP, The End of an Era

Fri, NOV 6th, 2015

This morning we received a very strong October jobs report, crushing estimates.

Job adds in the month: +271K (+90K above consensus)

Unemployment rate: 5% (lowest since 2008)

Wages, +2.5% Y/Y (better than forecast)

Average weekly hours worked, unchanged at 34.5 (a steady, healthy range)

The negatives in the report: September revised even lower to +137K net jobs vs. +142K prior estimate, and labor force participation remains at 62.4% (multi-decade lows) – though this is more structural and secular in nature (i.e., Baby Boomers retiring) than signs that the economy is bad.

Bottom-line: The prevailing jobs trend (strong) resumes, plus solid wage gains, plus recent Fed language deliberately putting December in play = December hike highly likely.

No September hike, but yes a December hike has been our House call for many months and seems much more likely given today’s data. The following excerpt is from my research note of July 29:

“Current Street consensus is for September 2015 [rate hike]. I think they’re wrong. My current baseline has been and continues to be Dec. 2015 for the first +25 bip hike. But this, of course, is contingent upon where the economy goes between now and the end of Nov., and most important if core inflation shows signs of creeping up toward target (>2%). It’s presently hovering around 1.3% (core). Monetary policy is not on a preset course and the Committee remains very data dependent.

Given the economic data we have now and my outlook for the economy over the near-term, I am currently thinking about it like this:

Sept. 2015 FOMC meeting, 10% odds

Dec. 2015, 65% odds

Early 2016, 20% odds

2H16, 5% odds

How is it that I’m so low for Sept. odds despite Street consensus? First, I just don’t see the economic pieces in place yet – mainly productivity growth, wage growth, and capacity utilization firmly >80% – that suggest inflation will move toward target by September. The Yellen Fed cannot afford a policy mistime at this point as it will impact their credibility and threaten years of economic progress. Second, even if we do see some inflation gains here I just don’t think there’s enough time between now and the Sept. meeting for inflation to show meaningful and sustainable gains where the Committee would feel comfortable going in Sept. There will be enough time, however, for a boost in NFP and wages in the autumn and leading into year-end. Too, Yellen has told us that they anticipate going in Dec. (“by year end”) so long as the data isn’t going in the wrong direction. I don’t expect a negative pivot.”

Despite these odds, nothing is a done deal when it comes to the Fed. They remain data dependent. But unless we see economic data sour meaningfully between now and December 15-16th, yes it is very-very likely that the Fed “goes” at their next FOMC meeting. Indeed, Yellen & Co. has deliberately put December firmly on the table with their October statement, Yellen Congressional testimony earlier this week, and Dudley comments (also this week). We also had Lockhart, a noted policy centrist, talking up December (though Fed presidents are lower quality gauges to Fed policy). Together, this has walked market expectations (again, in a deliberate attempt by the Fed) back to December and away from 2016, after what was weak jobs data in August and September and worries over global economic growth.

Anyone who has carefully listened to Yellen since the spring (rate hike will be “appropriate” by year end) – and has been paying attention to economic data (generally stable and improving) – knows that December was always “live” and what the Fed needed was a continuation of strong employment data and signs that wages were finally coming through, especially post-late-summer vol. We got past September, we got past October – both blips in the econ data – and it now seems these criteria have been met.

December probability, in my view, is now >90%.

Notwithstanding all of this hoopla, and as I’ve said many times before what is most important is not the timing of the first rate hike but rather the path of hikes. And here, I believe that the path will be slow and gradual. Consider this. In order to simply reach a real Fed funds of 0% the Fed will need to hike by 25 bips eight times (they could go more than 25 bips per meeting, but this isn’t likely unless inflation really heats up). As far as where the Fed ultimately ends up in the cycle my current base case calls for a terminal Fed funds of 3% to 3.75% (nominal). This seems appropriate given the economic backdrop, and would mark a lower stopping point than in many past Fed tightening cycles. My terminal Fed Funds suggests fourteen FOMC meetings at the mid-point to get there (almost 2 years) if they were to hike by 25 bips per meeting – though I do suspect they’ll pause here and there extending the process out beyond 2 years.

Big macro takeaway: The economic expansion – one of my “four pillars” to the equity market – remains healthy as job gains look good while wages, a lagging economic indicator, may finally be coming through.

If (when) the Fed lifts off from ZIRP (zero interest rate policy) in December this will mark, to the month and day, seven years of being pinned at a zero Fed Funds. It will be the end of an era for crisis-level monetary policy – a policy that shouldered, by an order of magnitude, the heaviest load in taking the economy from deep recession to durable expansion. The Fed has been smart, methodical, and, most important, bold, in their approach toward reviving the US economy. Any reasonable study of the past seven (plus) years, or fair reading of Bernanke’s recent book illustrate this fact. Despite this many have believed, and still believe today, that the Fed is “behind the curve.” Quite the contrary. All along the way the Fed has disproved its critics; deftly managed the delicate balance between monetary policy, the real economy, and financial markets; improved on the Fed’s communication program; and has generally played its salient role beautifully … like a well orchestrated symphony. We all owe them a debt of gratitude, or a hat tip at the very least.

FRI, NOV 6, 2015

Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group
(801) 487-3700