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Non-farm payrolls in the U.S. beat expectations (251k vs. 240k consensus) last week and the Unemployment Rate fell to 5.6%, its lowest level since June 2008. This was the 51st consecutive month of job gains, the longest streak in history.
Given this backdrop, investors must be expecting the Federal Reserve to raise interest rates sooner than expected, right?
Wrong. Expectations for the first Fed rate hike actually shifted further out in time after the report. Investors are now expecting the Fed to keep rates on hold at least until September of this year.
Why the shift in expectations, even after what was supposedly a strong jobs report? Weak wage growth, we were told, with average hourly earnings dipping to 1.7% over the past year. With CPI at 1.3%, real wages fell to 0.34%.
The Fed is watching this indicator closely, we are told, and will wait until real wages rise before raising interest rates. They will ignore any continued improvement in payrolls and the unemployment rate and focus instead on real wages.
Ok, sounds reasonable enough; we all want higher real wages. But is this consistent with what the Fed has done in prior cycles? After prior recessions did the Fed wait until real wages moved significantly higher before raising interest rates?
As it turns out, no they did not.
The 1990-91 recession ended in March 1991. The Fed cut interest rates until October 1992, down to a low of 3% (from as high as 9.75% in 1989). They initiated their first rate hike in February 1994, a 25 basis point move to 3.25%. What were real wages in the month prior to the first rate hike?
At 0.11%, they were actually lower than they are today. The Fed would hike rates from 3% to 6% from February 1994 to February 1995, and only after these hikes did we start to see a significant rise in real wages.
The 2001 recession ended in November 2001. The Fed cut rates until June 2003, down to a low of 1% (from as high as 6.5% in 2000). They initiated their first rate hike in June 2004, a 25 basis point move to 1.25%. What were real wages in the month prior to the first rate hike?
Again, at -0.88%, they were actually lower than they are today. The Fed would hike rates from 1% to 6.5% from June 2004 to June 2006, and only after these hikes ended did we start to see a significant rise in real wages.
From these examples it is clear that real wage growth has only come later in the cycle, and that there is no precedent for the Fed waiting for real wages to increase before raising rates.
But maybe it’s not real wages that the Fed is targeting after all. Perhaps it’s the unemployment rate. Here too the historical precedent fails us, as the Fed rose rates at 6.6% Unemployment Rate in 1994 and at 5.6% Unemployment Rate in 2004. Today, we are already down to a 5.6% Unemployment Rate and the expectations for a rate hike are still being pushed out.
The True Story
Still, some might argue that there is no harm in keeping rates at 0% for even longer if this brings about real wage growth. I might agree with that if there was any evidence of a correlation between the two. The truth is that the historical relationship between real wage growth and the Fed Funds Rate has been tenuous at best.
Which brings us to the unspoken elephant in the room: real wage growth during this recovery has been the slowest in history while the one constant during this period has been 0% interest rates. To say that keeping interest rates at 0% is going to help real wages, then, is an unbelievable leap of faith.
After six year of 0% rates, shouldn’t the onus now be on the Fed to prove that their policies aren’t actually hurting real wages?
Shouldn’t they be asked to explain how encouraging stock buybacks, M&A, and speculation in the stock market helps real wages? Or how a widening wealth gap created by 0% policy help real wages? Or how delaying older workers from retiring because of 0% rates helps real wages? Or how a massive misallocation of capital created by 0% rates helps real wages?
I don’t pretend to know what the appropriate level of the Fed Funds Rate is, but neither does the Fed. As I have illustrated, they have been letting the short-term movements of the stock market dictate policy in recent years, not economic data and certainly not real wages.
What I do know is that after six years the appropriate level is not 0% (negative real rates) if your goal is anything other than creating another financial bubble. By some metrics, we may already be there with the median P/E multiple for U.S. stocks at a new all-time high.
Source: James Paulsen, Wells Capital Management
Some might support such a goal of inflating bubbles, borrowing from the future to satisfy the whims of today. I personally don’t believe this is good long-term economic or monetary policy but it’s certainly a debate we should be having. In the meantime, let’s be clear and open about what the Fed is really targeting and not pretend that higher real wages are the ultimate objective.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
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