In markets, as in life, there are few guarantees, forcing investors to choose between likely outcomes. Following Friday’s strong U.S. jobs report, this means betting squarely on the Federal Reserve increasing its policy rate by 25 basis points to a target range of between 0.25% and 0.50% at its next policy meeting on 16 December. Few data between now and then are likely to meaningfully reduce this likelihood, because today’s data (an increase of 271,000 in nonfarm payrolls for October) leapt over the low rate-hike hurdle the Fed has communicated in recent weeks.
A month ago, following a weaker-than-expected 142,000 gain in U.S. payrolls, Fed officials began a campaign to signal that monthly payroll gains of between 100,000 and 150,000 would satisfy its rate-hike criteria for “some further improvement in the labor market.” This, despite the fact that it would be well below the roughly 230,000 monthly average of recent years.
Why did the Fed say this? Because it knows that gains of between 100,000 and 150,000 would still represent improvement, given that the growth of the labor force has been averaging about 70,000 per month. In other words, job growth in excess of 70,000 per month requires employers to reach into the pool of unemployed workers to fill job openings, reducing joblessness.
This raises the question: Wouldn’t the Fed want this to happen more rapidly and therefore hope for even stronger gains than between 100,000 and 150,000? Yes and no. Yes, because its objective is maximum employment and low inflation. No, because in order to keep the recovery even-keeled and to sustain it for hopefully years to come, the Fed needs to ensure that employment doesn’t grow too fast relative to the economy’s growth potential, which is about 2% or so.
So, while not guaranteed, the likelihood of a December hike suggests investors need to position portfolios for higher rates ahead.