After a surprisingly weak September payroll report, the October payroll report released this morning was a blowout, the best result since late last year.
Nothing like big time volatility in the economic data as the Fed’s December rate hike decision hangs in the balance. Payrolls were up 271,000 (vs. the 190,000 expected and the 137,000 reported for September) while the unemployment rate fell to 5%.
Wage pressure also increased to a six-year high — suggesting that inflation is actually awakening up after a long slumber.
With a December rate liftoff looking more certain now, a Santa Claus rally on Wall Street looks a little less likely now as investors face the first rate hike since 2006 at a time of low end-of-year volatility. Expect big, stomach-churning moves as folks respond to the prospect of the first monetary policy in nearly a decade.
In the end, the Dow Jones Industrial Average gained 0.3%, the S&P 500 lost a fraction, the Nasdaq Composite gained 0.4% and the Russell 2000 gained 0.8%.
Financial stocks led the way with a 1.5% gain, pushing up the value of the November Citigroup Inc. (NYSE:C) calls recommended to Edge Pro subscribers to a gain of 159%. The KBE Regional Bank ETF (NYSEARCA:KRE) gained 3.1% to bring its total gain to 9.4% since it was recommended to Edge subscribers less than a month ago. Bank stocks are getting a lift as rate hike expectations push up long-term yields, expanding net interest margins and financial sector profitability.
The “rate hike on” trade was strong, with Treasury bonds getting smashed, the dollar surging, gold breaking down and crude oil losing 1.5% to close at $44.52 a barrel. While stocks initially surged, the rest of the session was marred by volatility as the Dow Jones churned around its unchanged line.
To be sure, the Fed has the justification for rate liftoff it was looking for.
In an interview with Reuters yesterday, St. Louis Fed President James Bullard said that monthly payroll growth between 100,000 and 125,000 would be considered normal for this stage of the recovery. In an interview on CNBC today, Chicago Fed President Charles Evans called the October gain a “good number” and added that macroeconomic conditions “look like they could be ripe for an increase” in rates.
Market-based odds not put a December rate hike at around 70%, up from below 60% yesterday and around 25% back in October.
With job gains accelerating, and inflation pressure building with the annual gain in average hourly earnings up 2.5% for the best result since the recession, it would take a big miss in the November payroll report — the last before the Fed’s December policy decision — to keep a rate hike at bay.
A rate hike would finally reveal just how vulnerable the stock and bond markets are to a higher cost of credit; the great unknown after the greatest experiment in cheap money stimulus in human history. Make no mistake: The tightening of the labor market and budding wage inflation pressure is fantastic news for middle Americans.
As the chart above from UBS shows, the 5% unemployment rate has been associated with the start of significant upward pressure on wages and salaries.
But the risk is that the Fed fall behind on inflation and is forced to hike rates more aggressively than the market assumes, rattling financial markets. In fact, Paul Ashworth at Capital Economics expects the Fed funds policy rate to be close to 2% by the end of 2016. Compare that to current futures market expectations of rates to be around 0.85%.
For this reason, I recommended clients book profits today, raise cash and move into defensive positions ahead of what I expect to be the first significant pullback since the current stock market rebound started in September.
Market breadth — or the number of stocks participating to the upside — has rolled over badly since the Dow started hitting resistance at the 18,000 level.
Looking ahead, a number of Fed speakers will be on the calendar next week ahead of the release of the Job Opening and Labor Turnover data on Thursday and the October retail sales and producer price inflation reports on Friday.
Anthony Mirhaydari is founder of the Edge and Edge Pro investment advisory newsletters. A two-week and four-week free trial offer has been extended to InvestorPlace readers.
