Higher Wages Equal Fed Rate Hike

Federal Reserve Chair Janet Yellen gave her much anticipated comments on the potential for coming Federal Funds rate hikes. As usual the speech was subject to intense forensic interpretation. At first the conclusion was Dovish – no chance for a September rate hike. Upon further review, Fed Vice Chair Stanley Fischer and other Fed Board members muddied the waters by implying that a September rate was possible and current trends – SO FAR – allow for one or more rate hikes this year. Gold and Treasury Bonds soared and then collapsed as Yellen’s words were reconfigured.

Wages

What will it take for the Fed to hike again? There are many factors in this game of Clue to assess the health of our economy. We may talk about industrial production, new factory orders, utilization rates and consumer spending. For the Fed it really just comes down to the labor market. More specifically it’s all about employee earnings or wage inflation and overall inflation as measured by the personal consumption expenditure price index (PCEPI). Currently the PCE is about 1.6%, which is still well under the Feds 2% target. While overall inflation is low, the eagle eye of the Fed is all about wages of workers rising back above 3% towards 4%.  With nominal Wage inflation is currently at 2.5% and real labor earnings growth is less than 2%, the Fed is once again close enough for a preemptive hike with one more strong report in our opinion. 

Wage rate 8-16

Next Friday September 2nd, job growth and wage rates will be reported. Some expect another strong employment gain of more than 200,000 and solid wage gains. If real hourly earnings rise by o.3% or more we think the Fed will conclude on Sept’ 21 there is confirmation of an economic uptrend and rising inflation pressures that give justification for a rate hike. Of course wages may not rise next week and job gains may falter sharply thus postponing their decision, but any hint of wage inflation breaking out will be pounced upon by the many hawkish Fed Board members.   

Real Earnings in July 2016

As we mentioned months ago, the Fed is desperate to raise rates. Of course the motivation for hikes seems convoluted. Reviving the private bond market and fighting “future” inflation may excuses for “normalizing” yields higher, but the real reason by Fed heads is to provide room to lower rates when the economy contracts toward a recession “someday”. Essentially they want to raise rates, despite the weak economy, so they can lower rates when the economy becomes weaker.  The consensus of economists is for 2.5 to 3.0% GDP in the 3rd quarter from just 1% during the 1st half of 2016. Hawkish Fed voting members think we can average 3% GDP growth during the 2nd half of 2016. Given the weak Regional Fed surveys and slow service and industrial numbers two months into the 3rd quarter, such optimism is hard to fathom. With that said we have been expecting a cyclical economic low during the 1st half of 2016 and more obvious strength by early 2017. The sharp one year contraction in inventories certainly warrants a restocking boost to the 2nd half GDP reports. However, the curtailment of capital spending during this volatile election period seems to be holding back new order flows. Personally our domestic industrial machine sales quotes remain elevated, but delayed decision making is equally elevated. Political anxiety this quarter should not be overlooked. For now the theme is Fed Rate Hikes and a potential hike hinges upon a strong September 2nd jobs report and wage inflation.  Don’t take our word for it:  Fischer, the Fed’s No. 2 policymaker, said “the Labor Department’s jobs report for August will likely weigh on the decision over a hike. I think the evidence is the economy has strengthened… (with) the big numbers are better than they have been for some time,”  If expectations of a rate hike rise then we can expect lower stocks and bond prices short term.  Stay tuned!  Effective Federal Funds Rate FRED St. Louis Fed

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