Last week we suggested a rate hike from the Federal Reserve at its March 14-15 FOMC meeting should be a done deal barring an absolutely dismal reading for average hourly earnings in February. Fortunately, there was no such dismal reading in the February Employment Situation Report.
The Ides of March Beckons
Market participants won't know for certain if the FOMC raises the target range for the fed funds rate until the Ides of March. Nonetheless, the fed funds futures market is acting as if it knows what is coming its way.
The probability of a rate hike at the March meeting currently stands at 90.8%, according to the CME FedWatch Tool. That's up from 88.6% the day before the employment report, which is to say a market that had a pretty good sense already that the Fed would be raising the fed funds rate at its March meeting saw little reason to think otherwise after the employment report.
The proof of the pudding was evident throughout the report, yet the 0.2% increase in average hourly earnings sealed the deal in our estimation. That increase left average hourly earnings up 2.8% year-over-year, which was a shade below the 2.9% growth rate seen in December, which represented the highest year-over-year growth in average hourly earnings since June 2009.
One can see in the chart above that the Fed made its first move off the zero bound in December 2015 when average hourly earnings growth on a year-over-year basis was lower than it is today.
There is ample room still for average hourly earnings to increase even more. The broader trend is encouraging, though, and a likely signal to policymakers that it is safe to raise the target range for the fed funds rate again from its current level of 0.50% to 0.75%, which is a lowly range for an economy that isn't currently close at all to the throes of the financial and economic crises that took the fed funds rate to 1.00% in October 2008 and ultimately to the zero bound in December 2008.
What It All Means
With a rate hike of 25 basis points on March 15, the target range for the fed funds rate would be 0.75% to 1.00%.
When the fed funds rate was lowered to 1.00% in October 2008, there was a foreboding sense that things were going to get much worse. Today, there is a prevailing sense (in the stock market anyway) that things are going to get much better.
Time will tell, but as we alluded to last week, a window of rate-hike opportunity has opened up for the Federal Reserve. It would be foolish for the Federal Reserve not to climb through it based on the improvement in the employment and inflation data, which suggests it is prudent to take another step on the path toward normalization.
The Federal Reserve has taken two steps on that path already. A third step looks to be in order on the Ides of March and the market should not be wary of it for several reasons:
- It's good -- and accurate -- messaging that the U.S. economy is in better shape
- Frankly, it's what the market pretty much expects
- Global economic activity is improving
- It would provide some added policy cushion in the event a future problem necessitated a rate cut; and
- It's viable given that the economy and the stock market have stood the test of two prior rate hikes, which were made without as much supporting data