The recent market selloff and declining inflation expectations have lowered the probability of the Federal Reserve raising rates right away. However, the exact timing of the hike isn’t as important as the market implications of moderately higher interest rates, which are expected to eventually arrive.
While the recent market selloff and declining inflation expectations have lowered the probability of a September Federal Reserve (or Fed) rate rise, “good enough” U.S. economic data still support Fed liftoff occurring later this year. However, the exact timing of the hike—September, December or even early 2016—isn’t as important as the market implications of moderately higher rates, which are expected to come sometime soon.
Though the Fed is likely to raise rates gradually, higher short-term rates will ripple through the markets and affect a wide range of financial assets, including stocks.
The actual liftoff event will most likely lead to more short-term U.S. stock market volatility, so investors should expect a continued bumpy ride in the months ahead. That said, I do see potential opportunities in two particular U.S. sectors.
Although the recent market sell-off (VTI) and global volatility (VXX) eliminated a rate hike this week, US economic data still support Fed liftoff. The US economy expanded by an impressive 3.7% in 2Q15, much higher than earlier anticipated. Consumer spending (XLY) continues to be unfettered by the recent market turmoil (IVV).
Core US retail sales retail sales (XRT)—excluding automobiles, gasoline, building materials, and food services—rose by a solid 0.4% in August. The July core retail sales figures were revised upward to 0.6%. Overall retail sales increased by 0.2% in August, largely in line with expectations.
The labor market continues to display strength. The recent JOLT (Job Openings and Labor Turnover) report showed that job openings increased to a record high of 5.75 million in July, as shown in the above graph. This could mean that the unemployment rate could continue to tick down as more job opportunities are created for workers.
The unemployment rate decreased to a seven-year low of 5.1% in August. The civilian unemployment rate is now within the target range of the Federal Reserve, reflecting the improving nature of the US labor market, shown in the above graph.
The non-farm payroll data continues to remain solid. Although August saw non-farm payroll additions of only 173,000, there were other bright spots in the jobs report. Moreover, August figures are historically suspect to upward revisions in the following months.
According to the US Department of Labor, average hourly earnings grew by 0.3% month-over-month in August to $25.09. The average hourly earnings growth clocked in at 2.2% on a year-over-year basis.
It makes sense to start preparing for a rate hike, although the timing of Fed liftoff remains uncertain.