Russ Mould, investment director at AJ Bell:
“With today’s encouraging jobs number, a drop in the headline unemployment rate to 4.7%, headline inflation running at a four-year high of 2.5% and wage inflation coming in at 2.8%, the market is putting an 89% chance on a Fed rate rise on 15 March.
Percentage chance of rate hikes by Fed meeting in 2017:
| None | One | Two | Three | Four | Five |
| 0.75% | 1.00% | 1.25% | 1.50% | 1.75% | 2.00% |
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15 March | 11% | 89% |
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3 May | 11% | 82% | 8% |
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14 June | 6% | 49% | 42% | 4% |
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26 July | 5% | 40% | 43% | 11% | 1% |
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20 Sept | 3% | 25% | 42% | 25% | 5% |
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1 Nov | 2% | 22% | 40% | 28% | 8% | 1% |
13 Dec | 1% | 10% | 29% | 35% | 20% | 5% |
Source: CME Fedwatch
Three steps and a stumble
“Any increase next week would be the third of this cycle, following those of December 2015 and December 2016 and as such it would be a potential test for a rampant US stock market, given the old saying about “three steps and a stumble”. This would have knock on impacts for UK and global equities, too, as where the world’s largest and most liquid goes, the rest tend to follow.
“Analysis of the seven rate increase cycles seen in the USA since 1970 suggests the old saying has more than a grain of truth in it, something that should put investors at least on a state of alert as America’s S&P 500 flirts with new record highs and US stocks trade at near peak valuations on market-cap-to-GDP basis.
“The data clearly show that the S&P 500 has historically traded strongly into the first rate hike but then has lost momentum as monetary policy has been tightened making little or no progress, on average, for the 12-month period that followed increase in headline US borrowing costs.
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| Market response: S&P 500 Composite index | ||||||
1st Hike | 3rd Hike |
Before first rate hike | After third rate hike | |||||
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| 1 year | 6 months | 3 months | 3 months | 6 Months | 1 Year | 2 Years |
15-Jul-71 | 19-Jan-73 | 32.0% | 6.7% | -4.1% | -9.1% | -7.2% | -23.1% | -24.8% |
01-Aug-77 | 20-Sep-77 | -4.2% | -3.2% | -1.0% | -6.8% | 2.6% | 3.2% | 22.9% |
31-Mar-83 | 24-Jun-83 | 36.6% | 27.0% | 8.8% | -4.0% | -6.8% | -3.7% | 38.5% |
04-Dec-86 | 21-May-87 | 23.9% | 33.2% | -0.3% | 14.3% | -8.0% | -1.8% | 21.5% |
04-Feb-94 | 18-Apr-94 | 4.5% | 4.7% | 2.7% | 5.0% | 4.3% | 29.7% | 77.8% |
30-Jun-99 | 16-Nov-99 | 21.1% | 11.4% | 5.5% | 5.7% | 2.8% | -20.0% | -38.2% |
30-Jun-04 | 21-Sep-04 | 17.1% | 2.8% | 1.2% | 4.0% | 7.2% | 12.9% | 33.7% |
16-Dec-15 |
| 5.1% | -1.1% | 3.9% |
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AVERAGE |
| 17.0% | 10.2% | 2.1% | 1.3% | -0.7% | -0.4% | 18.8% |
Source: Thomson Reuters Datastream
“Such concerns are understandable, especially now. Although inflation and unemployment are currently sticking to the script, the US economic recovery remains tepid by historic standards – GDP growth has not exceeded 3% for a calendar year since 2005 – and the key reason for this could be debt.
“America’s federal government, local authorities, corporations and consumers have piled up huge additional liabilities, even since the Great Financial Crisis of 2007-09.
$ billion | Q1 2007 | 2016 |
Federal | 8,850 | 19,976 |
State * | 2,820 | 3,069 |
Total Government * | 11,670 | 23,045 |
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Mortgage | 13,798 | 14,187 |
Auto | 781 | 1,112 |
Credit card / other | 1,137 | 1,244 |
Student | 545 | 1,406 |
Total Consumer | 16,261 | 17,949 |
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Non-financial Corporate | 3,211 | 5,835 |
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Total Debt | 31,142 | 46,829 |
Source: FRED, St. Louis Federal Reserve database, Federal Reserve Bank of New York. *Excludes pension obligations.
“Taking that aggregate $46.8 trillion debt number and a US GDP figure of $18.5 trillion, every 0.25% interest rate hike adds $117 billion to the interest bill, or 0.6% of annual GDP.
“All of this means investors must remain vigilant if “three steps and a stumble” starts to show any sign of retaining its old force, even if markets right now are welcoming a third rate hike as a sign of economy strength and therefore a positive indicator for corporate earnings.”