Wall Street girds for the looming rate hike
A stock market accustomed to a dovish Fed will need to keep adjusting its expectations.
Rate hike worries hit investors again on Wednesday, after stocks had pretty much flat-lined for the previous several sessions. All it took was Federal Reserve Chair Janet Yellen sounding a hawkish note at a speech in Washington, D.C., where she talked up the economic risks of waiting too long to raise interest rates.
That -- and a breakdown in crude oil prices as OPEC appears unable to muster a production cut ahead of a quota meeting on Friday -- was all it took to make U.S. stocks move decidedly lower on Wednesday. Michael Feroli at JP Morgan told clients the big takeaway from Yellen's comments was that the conditions for a December rate hike were falling into place.
Specifically, Yellen mentioned that gains in the labor market had "bolstered" and "strengthened" her confidence that inflation would return to the Fed's 2 percent target over time.
Naturally, Stocks, bonds and gold all fell, as did crude oil, which lost 4.1 percent to close at $40.12 a barrel. But at least the economic front had some more of the good news Yellen was citing as the November private sector ADP jobs report was solid. Heading into Friday's U.S. nonfarm payroll report, the consensus estimate is for a 200,000 job gain.
Yellen's comments on inflation were the critical missing ingredient from the Fed's September rate-setting meeting. So, absent a major disappointment with Friday's jobs number or major financial market volatility, we're on the verge of the first rate hike since 2006.
Paul Ashworth at Capital Economics chimed in with support for this thesis by noting that unit labor costs increased at a 1.8 percent annualized rate in the third quarter. Over the last 12 months, those costs are up 3 percent as businesses have to compete for fewer qualified applicants.
Since unit labor costs are "the biggest input into production" in an economy like ours, Ashworth worries that inflation could rise faster than expected next year and prompt the Fed into a more aggressive policy tightening tempo.
Investors will hear more from Yellen on Thursday when she testifies before the Joint Economic Committee of Congress. You can be sure they'll be paying close attention.
