Analysis: How likely is the FOMC rate hike in December?

A lot can happen in a week and we have four weeks to get through before the next FOMC meeting, writes analyst Brenda Kelly of London Capital Group.

The latest import price numbers coupled with the most recent fall in retail sales, in what is deemed to be a consumption-led economy, could very well usurp the comfort some FOMC members appear to have when it comes to hiking rates before the end of the year

Inflation, and the lack thereof, something that the Bank of England and the European Central Bank have both decried have essentially led both central banks to change both outlook and tack.

The BoE said it doesn’t expect to hit its 2% inflation target for another two years, with lower commodity prices and a stronger pound continuing to weigh on consumer prices. The BoE has seen its efforts to raise interest rates complicated by falling commodity prices, a stronger currency and concerns over a slowdown in global growth.

Despite ‘guidance’ that interest rates hikes were likely when unemployment fell below 7%, we now see UK unemployment at a seven-year low, at 5.3%. Wage growth remains the barrier and while total wages rose by 2.0%, down from 3.2% the previous month, it marked the weakest increase since February. Thus the BoE has been validated in its decision to hold.

For those waiting for a sharp acceleration in Americans' pay, it does seem to have finally arrived .The average hourly wage paid to American workers rose 0.4% in October and posted the strongest 12-month gain since mid-2009. The typical worker earned $25.20 an hour in October, up 9 cents from the prior month. From October 2014 to October 2015, hourly wages rose 2.5%, the best year-over-year gain since the US exited recession in June 2009.

Annualized increases in pay had stuck to a tight range of 2.2% or less for the past five years, but economists have been expecting a faster increase amid a deep drop in unemployment and the creation of millions of new jobs. The amount of time people worked each week, meanwhile, was flat at 34.5 hours last month.

US CPI increased in October after two straight months of declines leading many to believe that the drag on inflation from a strong dollar and lower oil prices was starting to ease and again lending more support to the hike expectations from the FOMC.

One data point does not a trend make – we noted a similar wage growth spike back in March 2010 in the UK that ultimately came to nothing.

Last week’s GDP numbers in the Eurozone were all the markets needed to start not merely pencilling in the possibility of additional stimulus – it now basically expects it as a matter of form.

Recent Eurozone CPI data showed prices grew slightly more than originally estimated but still remain quite some distance below the ECB target range but could serve to underpin the notion that QE is actually starting to bear fruit.

Nevertheless, inflation expectations seem to be a concern of some ECB members and thus there is a general acceptance that we are on the cusp of an extension to the present QE and possibly negative interest rates.

Not only had the US 10Y yield reached technical resistance in the form of the downtrend since 2010 last week, the recent Fed-induced USD gains have also recently been weighing on commodity prices.

These developments have in turn been spilling over into lower commodity prices and through to somewhat weaker risk sentiment. The US 2Y yield has edged down to 0.839% while 10Y yields dropped back to 2.257%.

As it stands, we have base metal prices plunging to fresh six-year lows and with the copper price normally held in high esteem as a bellwether for the global economy the outlook would appear rather stark.

Copper prices now at lows last seen in 2009 - with smart money adding to shorts last week - has always been a decent window into China and indeed global growth. Some of this decline can be laid directly at the feet of dollar strength, but it would be disingenuous to suggest that there a lack of a demand element is also at play.

This being said, a rebound from current levels, despite the lack of perceived demand cannot be ruled out – given severely oversold readings and support from key technical levels nearby.

Given that China and the strong dollar were among the key concerns of the Fed in September, and the deciding factor (for all intents and purposes) in keeping rates as is, these worries appear to have dissipated.

Ironically, the dollar is weaker in the aftermath of yesterday’s October minutes release . While WIRP indicates the market is pricing in a 68% chance of a hike – data dependency still looms large.

Even oil prices, bid up earlier are now relinquishing intraday gains. Last week’s CFTC indicated that non-commercials added to shorts and it’s already looking like this was the right trade. Retail traders are 88% long oil futures, which should go some way to tell the near-term direction.

A lot can happen in a week and we have four weeks to get through before the next FOMC meeting but if and when the hike does come next month, given the reluctance we’ve witnessed to just get on and do it, there are plenty of reasons to think that Fed policy tightening will be gradual.

The fact that the words "some", "most" and "a number of" appear quite frequently in the FOMC minutes more than suggests that there is still some dovish dissension. The first hike is certainly not fait accompli just yet.

Brenda Kelly is head analyst at London Capital Group.