June 2006 – that was the last time the US Federal Reserve raised interest rates.
That’s nearly ten years ago. Can you really blame them for feeling a little bit rusty?
It’s no wonder that Janet Yellen and co had an attack of nerves last month when faced with the prospect of lifting rates from the zero level.
And they’ve just had the perfect excuse they need to put the dreaded task off for another six months…
The Fed isn’t raising rates in this environment
The US employment data (the ‘non-farm payrolls’ report) for September came out on Friday.
It wasn’t particularly encouraging.
The US added 142,000 jobs last month – that was well below the 203,000 the market had been expecting. Worse still, the total for August was revised down, from a similarly disappointing 173,000 to an even worse 136,000.
The jobless rate stayed at 5.1%, and wages grew at an annual rate of 2.2% – the same as the previous month.
In all, it was a weak report – it’s the first time since 2012 that payrolls have grown by less than 150,000 for two months in a row, notes John Authers in the FT. And when that happened back in mid-2012, says Capital Economics, “the Fed responded by launching QE3”.
According to Bloomberg, before the data came out, the market was divided as to whether there’d be a US rate rise this year – pricing it at a roughly 43% chance. Now Wall Street only sees a 29% chance of rates rising in December. The majority now reckons it’ll be March next year before a rise materialises.
Even Capital Economics, which has been among the most aggressive forecasters in expecting a US rate rise, grudgingly shifted its expectations for the first increase back until early 2016. “We’re not suggesting that QE4 is coming any time soon, but the Fed isn’t hiking in that environment.”
So is the US economy in trouble? Capital reckons not. Other than manufacturing – “which is getting hammered by the stronger dollar” – the general picture has been “pretty positive”. So “we wouldn’t be surprised if the economy had a stronger fourth quarter”.
But that won’t be in the data “for another few months, which means the Fed won’t be raising rates until early 2016”.
Bad news is good news
When the data hit the newswires on Friday, the stockmarket dipped at first. For those inexperienced in the ways of Wall Street, that would seem to make sense – if the economy is doing badly, shouldn’t stocks fall?
But of course, the reality is that bad economic news means no interest-rate rise. No interest-rate rise means that the credit keeps flowing and – crucially – that there’s no reason for the US dollar’s bull run to continue.
So, by the end of the day, the old relationships were firmly back in place – bad news for the economy was good news for the market. As Reuters reports, “US stock indices jumped over 1% on Friday as worries about the economy… gave way to a robust rally in energy and materials stocks”.
The rally continued in Asia this morning, with Japan’s Nikkei and other regional markets bouncing higher. Gold and bonds bounced too, with gold up more than 2% to over $1,130 an ounce.
In fact, the only real loser was the US dollar –and that’s where things get interesting. Ultimately, a stronger US dollar means tighter monetary policy around the world because everyone needs dollars to finance global trade.
So the US dollar bull market has put a lot of pressure on emerging markets, China and the price of commodities in general. But with a US interest rate rise being pushed further forward into the mists of time, it’s getting harder to make the bullish case for the dollar.
In turn, that suggests that monetary policy is set to loosen. And that’s good for asset prices.
As Capital Economist points out, it’s not just the Fed. A drop in the dollar will “simply increase pressure on the ECB to extend” its quantitative easing programme to prevent the euro from strengthening, “so we expect any gains in the euro to be short-lived”. It’s the same story for the Bank of Japan.
So we can expect both of those central banks to add more fuel to the fire.
What this means for investors
If the US dollar has topped out for now, it suggests the markets hardest hit by the strong dollar – commodities, emerging markets – may be near a bottom. I don’t expect a rampant recovery in commodities – too much oversupply – but the pain might be closer to ending.
It’s clearly also good news for gold. You should have some physical gold in your portfolio, but if you have a taste for risk it might also be time to take a look at what has been one of the most disappointing sectors in the market – gold miners. We’ll have more on the sector in the next issue of MoneyWeek magazine, out on Friday.
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