Investment Clock insights

Economic Times May 2016


Ian Kernohan

May 2016

Markets are virtually certain that the US Federal Reserve (Fed) will not hike in June, with the probability of a move priced at just 10%. While the Fed did signal a less aggressive path to their policy intentions in March (more in line with our own expectations of two hikes this year), their latest statement was a little less dovish: the previous statement included the sentence "global economic and financial developments continue to pose risks", however this reference has now been dropped in the wake of an improvement in global economic signals (eg. stronger activity data in China and the eurozone, and a sharp fall in high yield credit spreads). Some people may have been looking for a clearer signal from the Fed, however with the June meeting still some way off, they wouldn’t want to commit themselves too far in advance. 

As always when discussing Fed policy, labour market data remains key, and despite weakness in some other indicators, most labour related data remains reasonably robust: weekly jobless claims have fallen to their lowest level since 1973 (chart 1), while the total employment has been growing at around 200k per month, with labour market participation now rising. Manufacturing surveys suggest conditions here have become less of a concern. With core Consumer Price Index (CPI) inflation now running at 2.2%, the question for the Fed is – do these conditions still warrant “emergency” levels of interest rates?

We still think fears of an oil induced recession look overcooked: employment in the oil and gas sector is a tiny share of total employment, while energy related capex accounts for a relatively small (and falling) share of total equipment and structures spending. Both headline and core CPI have risen in recent months, and we expect headline inflation to rise further as the sharp decline in the price of energy seen in 2015 drops out of the year-on-year comparison. Given this backdrop, a summer hike in the main Fed Funds rate remains our central scenario.

On another issue, the likely contenders in the November US Presidential Election are now becoming more apparent: the Democratic Party seems set to select Hilary Clinton, while the Republican Party appears very divided on the merits of Donald Trump’s candidature. Given such a choice, financial markets will probably be happier with a Clinton presidency (partial continuation of Obama) than the more radical Mr Trump, however investors will not give this issue much consideration until after the party conventions in the summer.

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