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Anxieties rise as rate hikes approach

It’s finally here. Something that hasn’t happened since 2006. I’m talking an interest rate hike from the Federal Reserve, which is now far more likely to happen at its December policy meeting. The odds of a liftoff soared after the surprisingly strong October jobs report.

Payrolls were up 271,000 (vs. the 190,000 expected and the 137,000 reported for September), while the unemployment rate fell to 5 percent from 5.1 in September. Wages also increased at a six-year high pace — suggesting that inflation is actually awakening after a long slumber.

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And while investors were warming to the idea recently (as a reflection of a stronger economy), as rate liftoff approaches, many are getting cold feet.

Thus, Wall Street’s mixed performance on Friday. Treasury bonds got smashed, the dollar surged, gold broke down and crude oil lost 1.5 percent to close at $44.52 a barrel. While stocks initially surged, the rest of the session was marred by volatility as the Dow churned around its unchanged line. The S&P 500 lost a fraction.

For good reason: Many of the recent trends that have weighed on corporate earnings would worsen under a rate hike scenario. The dollar would strengthen further. Commodity prices would weaken. And the value of overseas profits for U.S. corporations would diminish.

Already, the headwinds are strong. According to FactSet data, of the 444 companies in the S&P 500 that have reported third-quarter results, 74 percent have exceeded earnings estimates. But only 46 percent have exceeded revenue estimates. And overall, earnings are set to decline 2.2 percent over last year in what’s shaping up to be the first back-to-back earnings quarterly decline since 2009.

To be sure, the Fed has the justification for a rate hike it was looking for.

In an interview with Reuters Thursday, St. Louis Fed President James Bullard said monthly payroll growth between 100,000 and 125,000 would be considered normal for this stage of the recovery. In an interview on CNBC today, Chicago Fed President Charles Evans called the October gain a “good number” and added that macroeconomic conditions “look like they could be ripe for an increase” in rates.

Market-based odds now put a December rate hike at around 70 percent, up from below 60 percent Thursday and around 25 percent back in October.

payrolls110615.gif

With job gains accelerating and inflation pressure building (the annual gain in average hourly earnings is now up 2.5 percent, for the best result since the recession), it would take a big miss in the November payroll report — the last before the Fed’s December policy decision — to keep a rate hike at bay.

That rate increase would finally reveal just how vulnerable the stock and bond markets are to a higher cost of credit, which is the big unknown after the greatest experiment in cheap-money stimulus in human history. Make no mistake: The tightening of the labor market and budding wage inflation pressure is fantastic news for middle Americans.

wages110615.png

As the chart above from UBS shows, the 5 percent unemployment rate has been associated with the start of significant upward pressure on wages and salaries.

But the risk is that the Fed will fall behind on inflation and is forced to hike rates more aggressively sooner than the market assumes. That would rattle financial markets grown accustomed to an ultralow cost of capital. In fact, Paul Ashworth at Capital Economics expects the Fed funds policy rate to be close to 2 percent by the end of 2016. Compare that to current futures market expectations of rates to be around 0.85 percent at that point.

As a result, stocks are looking vulnerable as market breadth — or the number of stocks participating to the upside — has rolled over badly since the Dow started hitting resistance at the 18,000 level.

Put simply: With higher rates coming, the bulls will likely go on strike.

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Anxieties rise as rate hikes approach Reviewed by on . It's finally here. Something that hasn't happened since 2006. I'm talking an interest rate hike from the Federal Reserve, which is now far more likely to happen It's finally here. Something that hasn't happened since 2006. I'm talking an interest rate hike from the Federal Reserve, which is now far more likely to happen Rating:
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