Macro Weekly – Will the Fed walk the talk?

by: Maritza Cabezas , Aline Schuiling

Macro-Weekly-6-November-2015.pdf (80 KB)
  • After a strong job report, the Fed is likely to raise rates in December
  • Germany’s industrial sector is going through tough times …
  • …but the outlook for the eurozone economy remains one of ongoing recovery

Just a few weeks ago, the Fed had been delivering mixed messages about the possibilities of a rate hike. The statement of the October meeting, however, introduced more hawkish language, increasing the probability of a December rate hike. We think that  October’s job report has made a liftoff  in December more likely. Although our base case was a rate hike in 2016, we think that the direction of the labour market is now undoubtedly a strong one, enough to get inflation back to the 2% target at a faster pace.

October’s US job report strong from many sides

The October job report shows that the US economy is shrugging off the impact of the earlier financial stress. Nonfarm payrolls increased by 271K in October after a downwardly revised 137K the previous month, while August was revised up by 17K. This increase in nonfarm payrolls was much higher than the consensus forecast of 185K. The unemployment rate edged down to 5% from 5.1% the previous months.  Average hourly earnings, increased by 0.4% mom, after being flat in September. Part time employed workers looking for a full time job also improved to 9.8%, the lowest since 2008. The participation rate, however, has remained unchanged since August, at 62.4%. The participation rate matters, but we think that it’s just a question of time before the labour market attracts more entrants. Finally, from a sector perspective hiring in the manufacturing sector remains soft, with no job gains in October.

What is the Fed looking for in the labour market?

One of the requirements for a rate hike this year is that “the labour market improves further”  as mentioned in the last FOMC statement. October’s and November’s labour market reports play a critical role in this decision. But that is not all. Chair Yellen, since the beginning of her mandate, has relied on a broader range of indicators to determine the slack of the job market.  There is not much concern about the nonfarm payrolls and unemployment rate. Both have been pointing to a tighter labour market in the past year. Meanwhile, indicators that measure the flows in the labour market, such as the quits and the hiring rates, have shown a moderate growth pattern. And there is increasing evidence that certain sectors are having more and more difficulty finding the right applicants.

The weaker spots in the labour market recovery, have been the participation rate, the still high number of part-time workers, who want to work full time (the U-6 measure) and wages. The Fed’s Chair has said that the unemployment rate can run below the 4.9%  – considered consistent in the long run with an inflation at 2%.  This would give the Fed more certainty that inflation would get back on track. There is still the November jobs report that would have to confirm this path. Stronger wage growth, for instance would help. A renewed tightening of financial conditions, resulting from a strong USD can, however, put a bit of pressure on the economy, but the underlying momentum seems strong enough to withstand this.

Market response to US job report

The strong job report triggered a sharp rise in bond yields and a stronger dollar. The more positive than expected report led markets to price in a higher probability of a  Fed rate hike in December this year (rising up to 72% from 58% before the release).



Tough times for Germany’s industrial sector …

Germany’s factory orders and industrial production both declined in September, as well as during Q3 as a whole. Factory orders fell by 1.7% mom in September, while industrial production declined by 1.1% mom. Consequently, during Q3 as a whole, orders fell by 2.8% qoq and production declined by 0.2. The details of the orders data clearly show that the weakness is concentrated in demand for German industrial goods from outside the eurozone. Indeed, domestic factory orders increased by 0.2% qoq in Q3, while total orders from other eurozone countries increased by 1.0%. Meanwhile, orders from foreign countries outside the eurozone plummeted by  8.6% qoq. These numbers probably reflect the relatively large share of the BRICs and other emerging markets in Germany’s exports (see graph). Moreover, the positive impact of the euro-depreciation in the second half of last year and first months of this year seems to be waning.


… whereas Germany’s domestic demand remains resilient

Meanwhile, domestic demand in Germany seems to be more resilient. Retail sales rose by 0.9 % qoq in Q3, following a 0.3% decline in Q2, which acceleration more than compensated for a sharp drop in car sales in Q3. Moreover, the services sector PMI increased during the past few months, rising from 53.8 in June to 54.5 in October, signalling stronger growth in services sector output in Q3. Also, construction output increased by 0.7% qoq in Q3, following a decline by 1.6% in Q2, suggesting that residential investment picked up as well in Q3. Finally, a rise in orders for capital goods by German companies signals that investment in machinery and equipment expanded as well. Thanks to the resilience of domestic demand, we think that GDP growth, which will we published on 13 November, merely slowed down from 0.4% qoq in Q2 to 0.3% in Q3. This was despite the negative contribution from industrial production.


Eurozone as a whole holds on to growth momentum

Despite the expected slowdown in German GDP growth, we still see growth in the eurozone as a whole stabilising at 0.4% qoq in Q3 (data will be published on 13 November, as well). Although GDP growth in Spain, (already released on 30 October) edged lower, it seems to have either picked up or stabilised in the other three big-5 countries (France, Italy and the Netherlands). Stabilisation of eurozone GDP growth in Q3 was also suggested by monthly indicators such as the composite PMI and the European Commission’s  Economic Sentiment Indicator.