Weekly Market Focus

Richard Jerram,
Chief Economist
Bank of Singapore, Member of OCBC Wealth Panel

Continued strong job growth in November
Fed set to hike again this week

Tax cuts argue for more aggressive Fed

The U.S. economy has completed its recovery after the September hit from hurricanes and the Fed is on track to keep on raising interest rates.

Another 228k jobs were created in November, which means that the 170k average of the past three months (38k, 244k, 228k) is in line with the average of 174k so far this year. In coming months we can expect job growth to revert to a more steady 150-200k pace.

Wage growth remains soft at 2.5 per cent YoY, but with the unemployment rate steady at a cyclical low of 4.1 per cent the Fed is set to raise interest rates again at its meeting on 12-13 December. In its September forecasts this is the level of unemployment that the Fed was expecting at the end of 2018, and with tax cuts on the way the probability is that it is well under 4 per cent by then.

There is a perception that the Fed talks tough but does not deliver. While that might previously have been the case, over the past year the Fed has hiked in line with its projections, and faster than the market expected. However, policy is still loose and the pace of tightening is still slow, so this is not proving to be disruptive.

The chart below shows how market expectations have moved up since the low of mid-2016. Risk assets have reacted calmly because the policy has reflected the “Goldilocks” environment of solid growth and subdued inflation. The coming year could be more difficult if inflation rebounds sharply.

At the moment the three rate hikes the Fed is projecting for 2018 look reasonable, but the risk is that tax cuts push them to be more aggressive. However, the bill has still not been passed by Congress, so it might be too early for the impact to be reflected in the “dot plot” after the upcoming Fed meeting.

Nevertheless, the basic observation is that Fed policy is geared towards slowing the economy down in order to stabilise the unemployment rate and manage the risk of inflation significantly overshooting targets. So far it has not had much success, in part because financial conditions have loosened this year, despite interest rate hikes, because of the weaker USD, rising asset prices and low volatility.

Tax cuts are likely to stimulate demand in 2018, which means that the Fed will be under pressure to be more aggressive. It is easy to see a shift to projecting four hikes in 2018, although perhaps not until March, by which time the tax cut bill should have been passed into law.

Fed Chair Yellen will have stepped down by March, but so far the nominations to the Fed board do not seem likely to tilt it in a significantly more dovish or hawkish direction.

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U.S. Jobs Keep Fed On Track