5 Min Read
(The opinions expressed here are those of the author, a columnist for Reuters)
By James Saft
Feb 3 (Reuters) - Don't look to the Federal Reserve to take away the punch bowl from the Trump party in risk assets.
Friday's payrolls data showed an economy creating jobs at a fair clip, but without the buildup in wage pressure which might force the Fed to raise interest rates rapidly.
In January, 227,000 jobs were added to the rolls but average hourly earnings grew at only 2.5 percent year on year, a disappointing figure given it included the impact from increases in minimum wages in many jurisdictions at the beginning of the year.
That means that with inflation accelerating, though low, and wage growth bumping along a bit higher, wages are now growing more slowly, in real terms, than they have over the past two and a half years.
Riskier assets like stocks rallied in response while government bonds sold off, as investors bet that the benefits corporate profits derive from fiscal stimulus and less regulation won't be diminished by a faster pace of rate increases.
"The evidence on labor market tightness abated in January. There is no additional pressure on the Fed to move beyond its indications of gradual rate hikes," Stephen Gallagher and Omair Sharif of Societe Generale wrote in reaction to the data.
Indeed, if anything, there is less pressure. Futures prices show that investors think the probability of a 25-basis-point hike at the Fed next meeting in March has halved from just before the payrolls were released, to just 9 percent. Traders further see interest rates ending the year at just a bit over 1 percent, implying just two hikes. This contrasts strongly with the Fed's own forecast from December, which predicted an end-2017 rate of 1.4 percent.
It may not last, but risk assets are now in an unusually sweet position: reflation without too much inflation. The sum impact of Trump policy changes on corporate profitability will likely be positive, at least in the short term, but the nagging risk is that rising rates prompt investors to impose a discount on the value of future corporate cash flows.
As that risk ebbs, little stands in the way of a continued rally.
And though the Fed does have reason to want to get a bit of sea room between it and the zero lower bound, leaving it some ammunition for the inevitable downturn, it also has some good reasons to want to let any recovery run on a little.
One school of thought within the Fed, decidedly dovish, is that after a once-in-a-generation downturn there is room to allow the economy to run slightly 'hot' thereby drawing discouraged and retired workers back into the work force and giving the great mass of labor an opportunity to enjoy above-inflation wage growth.
Charles Evans, a noted dove and a voting member of the Fed's rate-setting committee this year, sounded in line with this argument Friday in a speech, nodding both to the desirability of measured rate increases and lower unemployment. In this view, the rate of unemployment which the economy can have and not see inflation get out of hand has fallen.
Evans, though, goes further: "I expect that under appropriate monetary policy the unemployment rate will undershoot the natural rate a bit over the medium term. Modestly undershooting the unemployment goal for a time will help boost inflation toward its target," he said.
In other words, drawing workers back into the work force isn't just an instrument, at this point in the cycle, useful to achieve the Fed's employment mandate but even, at these very low levels, to its inflation one.
There was a good bit in the jobs report to support this view, and a good bit to allay other concerns as well.
Not only was wage growth subdued, but the sectors which might benefit from Trump border tax and other industrial policies, and which might employ the pool of labor now on the sidelines, seem if anything to be struggling.
The unemployment rate in durable goods manufacturing jumped to 4.5 percent from 3.7 percent, taking it to its highest in more than a year. Trump policies which otherwise might raise a red flag to Fed officials fearing inflation, like a border tax, may seem slightly less inflammatory today.
Remember too, equity investors, wage pressure leads to lower corporate profit margins. That may be coming, but not yet or not at a pace once feared.
Neither, it seems, will interest rate increases. The party may just be getting started. (Editing by James Dalgleish)