The latest round of U.S. employment data left investors and analysts scratching their heads over how many times the Federal Reserve could hike interest rates in 2016.
Heading into this year, Fed Chair Janet Yellen broadcast expectations for the possibility of four rate hikes in 2016, perhaps one each quarter. Now, she could be facing tough questions from Congress this week when she hits Capitol Hill.
A Quick Recap
Recent global growth concerns, equity market volatility, and spotty economic data have triggered a hasty retreat in rate hike expectations. For instance, S&P Capital IQ now expects only two rate hikes in 2016 versus its previous forecast of four.
The January employment report revealed a slower pace of new job creation in the U.S. at 151,000 versus the Briefing.com consensus at 188,000. What's especially worrisome to some market observers is that "we created jobs in retail and hospitality. Unless you are in management, those tend to be jobs, not careers," says JJ Kinahan, chief market strategist at TD Ameritrade.
The positive news was that average hourly earnings gained 0.5%, above expectations, which translates into a 2.5% gain over the last 12 months. Fed officials are looking for any sign that wage growth has legs, which could boost retail spending. Of course, there’s a fine line. Some industry economists view robust wage growth as potentially increasing the risk of inflation and of another Fed rate hike or hikes.
Faster wage growth complicates the picture, leaving a trail of uncertainty for traders and investors. "Right now if you look at Fed fund futures contracts, you have to go out to November to see a 30% chance of a rate hike. Odds are even slimmer before that," Kinahan says.
The U.S. stock market remains jittery and on edge. "The stock market believes the economy might not be strong enough to withstand a steady increase in short-term rates,” says Sam Stovall, managing director at S&P Capital IQ. “The global economic picture is not as strong. The U.S. manufacturing sector is already in recession, and inflation itself based on the [personal consumption expenditure] does not point to a spike."
Any Hints from Yellen?
Yellen delivers her semiannual monetary policy testimony before both houses of Congress starting on Wednesday. "Investors will likely be paying very close attention to Yellen's comments, trying to decipher if the Fed will stick with its quarterly rate hike tightening," Stovall says.
Renewed uncertainty over the Fed's pace of rate hikes injects potential for continuing market volatility this year as both stock and bond markets position for what’s next (figure 1). "The best thing for investors with a long-term time horizon is to turn off the television, because all you are doing is playing with your emotions," Stovall says.
Ready to Downsize?
For traders, "volatility is usually seen as a beautiful thing," notes Kinahan, because of the increased chance to enter and exit positions.
However, he also points out that more volatility could call for considering a smaller position size.