What does this week’s unemployment data mean for US interest rates?

On Friday this week we shall find out how the US Jobs market fared in September and whether there will be any additional impetus from the unemployment numbers, as far as the Feds actions on US interest rates are concerned. At the time of writing the Fed Funds Futures market is suggesting there is a less than 20% chance of the Fed pulling the trigger in October and despite Janet Yellens' recent comments to the contrary, a declining chance of a rate rise in 2015 at all.

In the press conference following Septembers FOMC meeting the Fed chair flagged that external factors rather than domestic ones had caused the monetary policy committee to hold rates at their current low levels. The question must be therefore even if we had much better jobs number than anticipated on Friday would this enough to persuade the Federal Reserve to act?

The chart below shows both the Non-Farm Payrolls data and the underlying US Unemployment rate over the last five years. During this time we have seen job creation rates which have rarely dipped below 100k per month and a declining rate of unemployment, which is now just above 5% and approaching levels that could be considered as being at or near full employment for the USA.

Given this relatively benign employment outlook it's tempting to think that we could be "pushing on a string" if we expect jobs data to be the catalyst for an early US interest rate rise. Consensus forecasts for Fridays NFP are at 203,000 according to data from Bloomberg / Econoday.

If US interest rates aren't likely to be influenced by domestic employment data what factors could make a difference?

The Fed considers other items in its mandate including inflation, where it is attempting to engineer a move to its 2% target rate. There is much debate about which measures of inflation most accurately reflect price changes in modern globalized economies. But if we consider core inflation (think the CPI number minus the Food and Energy Components) in the US, then we are closer to this 2% threshold than you might imagine at 1.8%. However the picture becomes much less promising if we overlay this with the broader inflation rate (at just 0.2%) which includes Food and Energy prices. As can be seen in the chart below.

Core inflation is the solid black line whilst the broader inflation rate is the lighter dotted line.

China and the Emerging Markets

The latest factor to be introduced into the equation is the performance of the global economy and in particular China and the Emerging Markets. We have spoken on numerous occasions about the vulnerability of the Emerging Markets and the uncertainty about the real state of play in the Chinese economy and at times we have felt like a voice in the wilderness.

However our view is now starting to become the orthodoxy. In a recent research note Citigroup suggested that "Real" China GDP growth rates are perhaps nearer to 4% than the headline figures of 6.8% to 7%. Admittedly this is an estimate based on the banks modelling of the Chinese economy with all the assumptions that this entails. Nonetheless this does not bode well for the future and would certainly suggest to me that a hard landing is the most likely outcome for China.

In fact some commentators have taken the view that the hard landing is happening now, it's just that the official data has yet to fully reflect it.

What could this mean for Monetary Policy in the US and beyond?

In its recent strategy note Citi flagged a 55% possibility of a China led global recession occurring by the second half of 2016. That number can be broken down as follows: A 40% chance of a moderate recession and a 15% chance of what Citi calls "a severe recession and financial crisis".

But we should also note that Citi allocated a 30% chance to the global economy effectively moving sideways, neither growing nor contracting. A sideways move in the World economy or the expectation of one, would likely stay the Feds hand for longer, a mild global recession might persuade it to consider additional targeted stimulus.

However a severe recession in the global economy would put the Fed in very difficult positon. As it would have little room for maneuvere, as far as cutting rates was concerned, without considering crossing into the bizarre world of negative interest rates and the possibility of a fourth round of QE.

We could also see some of the remaining fiscal and monetary taboos broken in these circumstances via what is known as monetisation. Where in effect the Government and Central Bank print money to spend in the real economy or pay down government debt. Historically this type of action has been associated with the currencies of failing states and has been considered off limits to stable developed nations. However that could now change, with Japan seen as the most likely candidate to break ranks in any further economic adversity.

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