After Yellen’s teaser, markets hope for Draghi the easer.
A solid November job gain of 211,000 showed that despite weak overseas growth and struggling U.S. factories, the U.S. economy appears healthy enough to withstand a Fed hike from record-low rates later this month.
Fed Chairwoman Janet Yellen didn’t just all but promise a December interest rate hike last week, she also opened the curtain on a tough new era for investors.Asian stocks fell for a second day, following US equities lower, as investors braced for higher interest rates following Federal Reserve chair Janet Yellen’s latest comments.LONDON, Dec 3 (Reuters) – Investors were hoping for another bit of Mario Draghi magic on Thursday, after risk assets were left bruised by comments from the head of the Federal Reserve that she was “looking forward” to hiking U.S. rates. Analysts said it was near certain that the Fed, after keeping policy on hold for months awaiting more evidence of economic strength, would undertake its first rate increase in more than nine years at its upcoming meeting.
Gentle and gradual the pace of rate hikes may be, but the long period of easy money — by some accounts the lowest interest rates in 5,000 years — has lulled both stock and bond investors into positions and assumptions that will soon prove dangerous. European stocks were up 0.7 percent near 3-month highs and the euro was at a 7-1/2-year low, with Draghi expected to expand the European Central Bank’s money-printing programme later and hike the cost for banks that hoard cash. While the strong November employment data hid some signs of nagging persistent slack in the market, Fed Chair Janet Yellen made clear this week she believes that will slowly dry up as the economy continues to grow, and was no barrier to a rate increase. “The November jobs report was the last hurdle for a December Fed rate hike,” said Nariman Behravesh, chief economist at IHS Global Insight in a note.
The central question for investors is always: “How much risk is it sensible to take to get a given amount of incremental return?” That concept is called the efficient frontier. It followed a fresh spurt by the dollar overnight that had sent gold sliding to a new 5-1/2-year low and other commodity and emerging markets tumbling back again. With the new data, “a rate hike at the December 15-16 Fed meeting is (almost) a sure thing.” “The Fed will raise rates in December and data are now being watched primarily to determine how quickly rates rise next year and beyond,” echoed Chris Low, economist at FTN Financial.
Those moves were triggered by Federal Reserve chief Janet Yellen when she said on Wednesday that raising U.S. rates, something the Fed is expected to do for the first time in nearly a decade on Dec. 16, would be proof of the economy’s recovery. “When the Committee begins to normalize the stance of policy, doing so will be a testament … to how far our economy has come,” she said, referring to the Fed’s policy-setting committee. “In that sense, it is a day that I expect we all are looking forward to.” It left the focus firmly on the ECB’s moves later and traders wondering whether whatever comes out of Frankfurt will be able to offset the impact of higher Fed interest rates, which tend to drive borrowing costs globally. “But the impact of central banks is meeting the wall of diminishing returns… so he will have to do more and more and more, and even then it won’t have the same effect.” Money markets are pricing in a cut of at least 10 basis points in the ECB deposit rate to minus 30 basis points, while economists in a Reuters poll expect an increase in asset buying to 75 billion euros a month from 60 billion euros. Australia’s S&P/ASX 200 shed 0.6% to 5,277.70. “The US economy has had the training-wheels support of ultra-easing monetary policy, and suddenly they’re being told by their parent — the Fed — it’s time to take them off,” said Shane Oliver, head of investment strategy in Sydney at AMP Capital Investors, which oversees about US$110 billion. “Naturally, the markets, like the child, are feeling nervous.” In a speech at the Economic Club of Washington, Yellen also warned that waiting too long to end the era of near-zero interest rates could force the central bank to tighten too quickly, which would risk disrupting financial markets and the six-year expansion. They include a strong dollar, which has made exports pricier overseas and squeezed U.S. manufacturers, and sinking oil prices, which have led drilling companies to slash orders for steel pipes and other equipment. A broad range of industries were expanding payrolls at a strong pace: construction, retail trade, finance, education and health, business services, and restaurants and hotels. Morgan Stanley sees U.S. equity returns next year at 6 percent, and a 5 percent average over the next decade, both figures in the bottom half of the typical distribution.
Yellen will speak before the US Congress and November payrolls data is due on Friday, probably the most-anticipated piece of American data before the Fed’s Dec 16 interest-rate decision. “There’s a lot of anticipation of ECB easing and it seems to be pretty much the consensus that it will happen,” said Oliver. “The question is if the ECB can surprise the consensus, and I suspect it’s going to be hard.” The euro fell 0.6 percent to $1.0553, while the dollar index, which measures the greenback against six top world currencies, was hovering just below a 12-1/2-year high of 100.51 it had hit overnight. There were still weaknesses in the report: average wage gains remain slow; the ratio of working age people participating in the labour force is historically very low; and the number of people forced to take part-time jobs increased by 319,000 to a still-large 6.1 million.
Wall Street futures pointed to a spritely 0.6 percent rise for the S&P 500 when it resumes, although that would be merely taking back some of the near 1 percent lost during Wednesday’s volatility. But overall the report indicated a firming of the jobs market and resilience in growth that would allow the Fed to begin raising its benchmark federal funds rate after keeping it locked near zero for seven years, economists said. MSCI’s main regional index fell 0.4 percent as shares in South Korea, Hong Kong Australia Malaysia and Singapore dropped and as Tokyo’s Nikkei ended flat. News that the country’s parliament had launched impeachment proceedings against President Dilma Rousseff cheered investors who have been critical of her handling of Latin America’s biggest economy, now deep in recession. “Brazil is probably the biggest concern among emerging market countries at the moment, similar to the way that Russia was regarded a year ago,” said UBS strategist Manik Narain, adding the market’s view was that impeachment could pave the way for greater reforms in Brazil. For the Fed, conditions seem nearly ideal for a period of small and only gradual rate increases in coming months: Job growth has been solid, and wages have begun to rise but not so much as to cause concern about future high inflation.
In commodities, oil bounced as much as $1 on bargain hunting following its tumble overnight and following a report that Saudi Arabia will propose at Friday’s OPEC meeting that the group cuts output by 1 million barrels a day next year. Those numbers may actually look good to the large number of investors and pension funds who, stung by the great financial crisis, loaded up on government bonds. “As 10-year Treasuries fell to 1.6 percent in 2008 and stocks got liquidated in the financial crisis, two five-standard-deviation events conspired to elevate bond investments in popularity and thrust bond portfolio managers into godlike status,” William Smead of Smead Capital Management in Seattle wrote to clients. The ride down in interest rates hasn’t necessarily been that painful for those with heavy bond allocations, but it won’t take much of a rise in rates for the pain to become intense.
Andrew Haldane of the Bank of England, citing a long list of sources, in July asserted that rates are now as low as they have been since at least 3000 B.C. “We think a good rule of thumb is to avoid portfolio success stories created by five-standard-deviation events. Both figures point to strong demand for workers. “Companies are holding onto people pretty tightly, and at some point that’s going to manifest itself in higher wages,” said Michael Dolega, senior economist at TD Bank. “Their workers are going to get poached. Smead, for his part, posits that if rates go back to their traditional 3 to 6 percent range then it will likely be as a result of economic growth which could benefit sectors like consumer goods, or help financials which would dearly like to see a steeper yield curve. Dolega said wage gains are being held back by steep job cuts in mining, a category that consists mostly of oil and gas drilling and has shed 14 percent of its jobs in the past year.
Government data show that drilling firms were handing out big raises as recently as last year to attract workers, but average pay in the industry is now declining. CEO Tiger Tyagarajan says Genpact has added about 400 people to its 4,000 person U.S. workforce this year, many of them in highly skilled areas such as software programming and management consulting.