President Trump wasted no time reacting to the solid non-farm payrolls released on Friday, tweeting “Wow! These are incredible numbers. Keep it going, vote Republican!” – a welcomed boost for Trump and his supporters ahead of the mid-term elections this week.
Admittedly, the data speaks for itself and gives Trump plenty of ammunition to gloat. Another 250k jobs were added in the US in the month of October, with the unemployment rate at an astonishing 3.7%, the lowest level we have seen since Hendrix closed Woodstock back in 1969. But even more noteworthy is that wage growth climbed to a near decade high at 3.1%, comfortably above the current US inflation rate of 2.3%. It is this wage inflation that supports the Federal Open Market Committee (FOMC) to continue to increase interest rates, resulting in an 80% probability for another US rate hike in December.
So does this mean US employers need to offer higher wages in order to attract workers, therefore pushing inflation higher? It appears that the FOMC believes so and it is set to counter this dilemma by continuing to raise interest rates, much to the President’s dissatisfaction. It is a fine balancing act for the FOMC to undertake, given such policies will eventually start to put brakes on the US economy.
However, with the US economy passing its recent health check by growing at 3.5% annualised in the third quarter, the FOMC has headroom to work with. As for Trump, he must be keeping his eye on 2020 when he will almost certainly be seeking re-election and what he doesn’t want is an economy struggling with higher interest rates.
Emerging market politicians might side with Trump in his disdain for tighter monetary policy. When US rates push higher, USD denominated debt in emerging markets becomes more expensive. Emerging market governments and companies have stacked up an incredible 2.7 trillion of US dollar denominated debt, up to 2025. This figure has tripled over the last 10 years, aided by a ravenous China.
Many of the most vulnerable countries have already made headlines with weakening currencies. For example the Argentinian peso has depreciated by 91.5% since the beginning of the year and the Turkish lira by 43%. In a frantic response, Argentina has had to raise interest rates to 60% from 45%, and Turkey raised interest rates by 11.25% in April to 24% currently. This puts hedging emerging markets’ FX risk high on investor’s agendas, but at the same time the cost to hedge it is arguably expensive, due to unfavourable forward points driven by high interest rate differentials.
Fortunately, this is not the case for all emerging market countries. Take Colombia for example, its Central Bank has cut rates from a high of 7.75% in 2016, to 4.25%. If the US continues to raise interest rates, the cost of hedging the Colombian peso against the US dollar may become negligible – it is already sub 2% over 12 months. What is clear though, the influence of the US dollar and rates does not stop at the border. Now more than ever, it is extending to all corners of the globe.
Economic data highlights for this week are Q3 GDP from the UK along with trade data. The Q3 GDP is expected to grow by 0.6%. In Europe, German factory orders will be a key focus to determine how well the German economy is holding up. In the US, politics and the mid-term elections, as well as the FOMC rate decision will steal the headlines.
For more information, please contact Chris Towner, Director at Chatham, at email@example.com.