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 Bonds, which have already had an ugly few weeks, would come in for
more.
Job creation blew through expectations in February, with 295,000
positions added, as the U.S. jobless rate sank to a 6-1/2-year low
of 5.5 percent. Average hourly earnings are rising at a 2 percent
annual clip, slightly down from the month before but well in excess
of consumer inflation.
Now neither the trend nor the absolute numbers are consistent with
zero interest rates, especially given that an unemployment rate of
5.5 percent is arguably within the zone where wages rise to attract
labor.
The most likely course: the Federal Reserve moves deliberately but
rapidly to make its first move upward in rates in the post-crisis
era.
"We expect monetary policymakers to drop 'patient' from the
communiqué following the March meeting, setting the stage for an
initial liftoff in rates in June," Brian Jones, economist at Societe
Generale, wrote in a note to clients.
While there is still disagreement within the Fed, even John Williams
of the San Francisco Fed, who is usually counted among the doves, is
making impatient noises.
"Overshooting our target would force us into a much more dramatic
rate hike to reverse course, which could have a destabilizing effect
on the markets and possibly damage the economic recovery," Williams
said on Thursday before the payrolls data was released.
"I see a safer course in a gradual increase, and that calls for
starting a bit earlier."
And while markets moved to narrow the gap on Friday, there is still
a startling disconnect between their expectations of the rate of
ascent in rates and those of the Fed's own forecasts. Before six
weeks or so ago, the market had it pretty much its own way, but if
that tension is going to be resolved in favor of the central bank,
as these things usually are, the clear risks for most financial
assets are to the downside.
The next FOMC meeting on March 17-18, ending with an interest rate
decision, statement, new forecasts and a press conference by Janet
Yellen, is the most likely venue for the resolution. If the Fed
drops "patience," the reality of a rate rise at the June or July
meeting will be inescapable.
FINANCIAL ASSET RECKONING
Between now and March 18 we can expect the financial markets to
focus not on the good news of the moderate strength of the U.S.
economy but on just what more expensive money does to stocks and
bonds.
Equities got a start on Friday, with the S&P 500 falling 1.5
percent, leaving it clinging to about a half a percent gain for
2015. Ten-year Treasuries sold off even more strikingly, sending
yields up 13.5 basis points to 2.25 percent, a rise of more than 6
percent. Ten-year yields have risen by more than a third since Feb.
2.
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If the bond market move is sustained and extended, or perhaps more
to the point, if nothing dramatic happens in the economy to change
the apparent direction of travel, investors are going to start to
think through a markedly less friendly scenario for equities.
The strong performance of equities in the U.S. has benefited from
two strong tailwinds. First monetary policy, up until now, has been
designed to shake money out of safety and into riskier assets.
Higher interest rates don't just diminish the value of the stream of
future cashflows which a share in a business represents, they also
change the balance between risk and return.
The second equity tailwind has been high corporate profitability,
based in part on the long-term fall in the share of takings which
companies have been forced to pay out in wages and compensation.
Wages may now be on the rise. Wal-Mart recently said it would spend
about $1 billion raising wages and improving schedules for 500,000
of its lowest-paid employees. Others like retailer T.J. Maxx have
made similar moves. The Fed's Beige Book also noted employers in the
Atlanta and Chicago Fed districts were raising wages for unskilled
and entry-level workers. The number of workers voluntarily quitting
is also up 12 percent year on year.
Rising wages are welcome but imply falling margins.
Falling margins and rising interest rates are an unlovely
combination for riskier assets, even in a recovery.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be an
owner indirectly as an investor in a fund. You can email him at
jamessaft@jamessaft.com and find more columns at http://blogs.reuters.com/james-saft)
(Editing by James Dalgleish)
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