The jobs report for December was on the hawkish side for the Fed, due to a combination of higher wage growth and a fall in the underemployment rate (a broader measure than the headline unemployment rate, which is one of the Fed's favourite slack indicators).
One of the big questions this year is how many Fed hikes to expect. In our view, there are three triggers for the next Fed hike (assuming markets stay calm and the economic recovery continues): (1) higher wage growth to ensure a sustained increase in core inflation, (2) a lower unemployment rate (absorbing remaining labour market slack) and (3) higher actual PCE core inflation. The December jobs report was good news in terms of point 1 and 2.
We still expect two Fed hikes this year (June and December) in line with market pricing but, in our view, the jobs report has increased further the probability of a third hike. The FOMC minutes revealed that 'almost all' FOMC members think there are upside risks to their growth forecasts due to the likely fiscal boost, which they have not fully taken into account.
We still believe the Fed is likely to increase its hiking pace in 2018 (late 2017 at the earliest), as we think Trump's fiscal policy is likely to have the biggest growth impact in 2018 due to policy lags, although much could still happen before 2018.
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