The latest monthly jobs report contained some good news for the U.S. economy, with the labor market continuing to show improvement in July, likely putting the Federal Reserve on the verge of raising its policy rate for the first time since 2006.
Payrolls expanded by 215,000 in July, just a notch above the average pace for 2015, and the jobless rate held steady after a big drop in June brought it to its lowest level in the post-crisis economic expansion.
Markets responded to the data by boosting the odds of a rate hike at the Fed’s September 17 meeting to around 50% (according to fed fund futures data). The reaction was in fact rather muted, despite fears that increased odds of a September hike might spark added volatility in markets.
We see three important takeaways from the market reaction:
- Janet Yellen is proving to be the best dentist the bond market has ever had: In other words, she and her colleagues are succeeding in preparing markets for the possibility of an interest rate hike, numbing investors against any pain at the first “appointment,” by convincing them to focus more on both the speed and distance of the path of future rate hikes (which we believe will be slow and shallow). This shift in focus is helping limit market volatility, keeping market interest rates low.
- The yield curve is where the action is: Amid low inflation, bond investors are adjusting to future rate hikes primarily by pushing up short rates, not longer-term rates.
- The central bank divergence theme is intact: Markets believe the Fed will be raising rates while other global central banks are either cutting rates or keeping their rates pinned near zero. This is supporting the U.S. dollar.
Today’s muted response to the jobs report and its implications for Fed policy is a microcosm of what we expect in the next three to five years, with low policy rates globally remaining supportive of equity and credit markets, as well as real assets.