Two “Data” topics today:
#1: An update on what Fed Funds Futures are predicting for 2022 rate policy. Three points on this:
First, the odds of a 50 basis point liftoff hike at the March meeting remain well in the range of “yes, they may actually do that”, at 27 percent. As we’ve noted in recent reports, the Fed has not started a rate cycle with a 50 bp increase since at least 1990. Such a move would therefore be very unusual, but Chair Powell has repeatedly said the current environment is unlike any other in recent memory. The odds of a 25 basis point hike stand at 73 percent, which means markets (rightly, in our view) believe March will see the Fed raise rates.
Second, the odds for the June meeting reflect total confidence that that Fed will increase rates at all three meetings (March, May, June) between now and midyear. The probability that rates will be 75 – 100 basis points (3 hikes of 25 bp apiece) after the June meeting stand at 65 percent, with 35 percent odds they will be higher than that. The difference between the latter probability and March’s 27 percent odds of a 50 bp hike tells us that Futures are putting some non-zero probability on a 50 bp move in May or June.
Lastly, Futures put the highest odds of Fed Funds ending the year at 150 – 175 basis points (33 percent probability), which would be 6 hikes of 25 basis points apiece across 7 FOMC meetings. The second highest odds go to 125 – 150 basis points (30 percent, 5 hikes of 25 bp) and the third highest probability is for 175 – 200 bp (18 pct, 7 hikes of 25 bp). Add up those odds, and you get an 81 percent probability that there will be 5 – 7 hikes of 25 basis points apiece this year.
Also worth noting: 2-year Treasuries yield 1.36 percent today, the highest reading since February 2020. This market has been a bit slow to confirm the signal sent by Fed Funds Futures, but current yields now fit with the narrative of aggressive Federal Reserve policy in 2022.
Takeaway: Fed Funds Futures are fully pricing in 5 – 7 rate hikes of 25 basis points apiece this year and putting some real probability of an unprecedented 50 basis point increase to the start of the process in March. Here’s how we think about that:
- While hikes at virtually every FOMC meeting may sound like an especially high “wall of worry” for equity markets to climb, the same thing happened from June 2004 to June 2006.
- The Fed raised rates by 25 basis points at 17 meetings (every single one) across that timespan, starting with 1.0 percent Fed Funds and ending with 5.25 pct.
- The S&P 500 had a total return of +10.7 percent in 2004, +4.8 pct in 2005, and +15.6 pct in 2006.
The point here is US equities can do fine during periods of rising Fed Funds as long as markets feel that monetary policy is predictable. It was certainly that in 2004 – 2006, even as the Fed pushed rates ever higher. How the current day Federal Reserve manages this challenge in 2022 could well be what determines if US stocks end the year in the plus or minus column.
#2: Why are US wages running so hot? One way we can answer this question is by looking at the current employment status of younger Americans. Whereas this group was disproportionately hurt by the Financial Crisis, they’ve bounced back much quicker from the Pandemic Recession. The smaller this pool of available workers, the more businesses have to offer to attract and retain new employees.
Here are the unemployment rates for young workers with and without a college degree versus the last cycle using data from the New York Fed out today (rates are seasonally adjusted and calculated as a 3-month moving average back to 1990):
#1: Unemployment rate for recent college graduates (aged 22 to 27) with a bachelor’s degree or higher:
- 4.8 percent as of December 2021 (latest available data), a post-pandemic low from the high of 13.3 pct in June 2020.
- Peaked at 7.9 pct in December 2010 after the Great Recession and did not fall to 4.8 pct until April 2015.
- Difference: it took 18 months for this rate to fall by 8.5 percentage points in the latest cycle versus 52 months to drop by just 3.1 percentage points in the prior cycle to get to the same 4.8 pct rate.
#2: Unemployment rate for all college grads (aged 22 to 65):
- 2.5 pct as of December 2021, a post-pandemic low from the high of 8.0 pct in June 2020.
- Peaked at 5.1 pct in December 2010 after the Great Recession and did not drop to 2.5 pct until January 2016.
- Difference: it took 18 months for this rate to fall by 5.5 percentage points in the latest cycle versus 61 months to decline by just 2.6 percentage points in the prior cycle to get to the same 2.5 pct rate.
#3: Unemployment rate of young workers without a bachelor’s degree (aged 22 to 27):
- 7.5 pct as of December 2021, a post-pandemic low from the high of 21.4 pct in June 2020.
- Peaked at 16.4 pct in May 2010 after the Great Recession and did not drop to 7.5 pct until May 2017.
- Difference: it took 18 months for this rate to fall by 13.9 percentage points in the latest cycle versus 84 months to drop by just 8.9 percentage points in the prior cycle to get to the same 7.5 pct rate.
Takeaway: each of these cohorts’ unemployment rates have declined much faster than after the Financial Crisis, reducing the supply of available labor even as demand remains robust. This ongoing imbalance continues to put upward pressure on wages as employers face fierce competition for talent across all skill levels. Usually, the most educated and experienced workers get hired first after a downturn. Then, employers tap cheaper sources of labor such as younger workers or those without degrees the longer an economic expansion persists. Both have happened more concurrently in the most recent environment, however, as employers try to capitalize on a fast and strong US economic recovery amid record job openings and quits.