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Fed Policy Is Still Directing The U.S. Economy And Investor Sentiment

S&P Capital IQ Global Markets Intelligence (GMI) Research believes that two economic indicators will predominantly guide risk-asset pricing in the coming year: the pace of non-farm payroll creation and the direction of core consumer price inflation (core CPI).

The U.S. economy added 214,000 new payroll jobs in October, the ninth consecutive month of job creation in excess of 200,000, marking the longest string since between September 1993 and March 1995. More importantly, the U.S. unemployment rate, inclusive of marginally-attached workers and those employed part-time for economic reasons (i.e. U6 unemployment), is now declining precipitously. The U6 unemployment rate dropped to 11.5% in October from 12.0% as recently as August, continuing the significant improvement seen since this particular metric of joblessness peaked at 17.2% in April 2010 (see chart 1). Also indicative of a rapidly improving U.S. employment situation and perhaps even a tightening of labor market conditions, the four-week average level of initial jobless claims dropped to 279,000 as of the week of Nov. 1, which is the lowest level recorded since late April 2000. 

    Source: U.S. Bureau of Labor Statistics

As the U.S. labor market gradually tightens, the optimal outcome for investors holding at least market-weight exposures to risk assets is one where core CPI inflation maintains a slow and marginal escalation that takes a year or preferably even longer for core CPI to rise from 1.7% today to about 2% or slightly higher toward the tail end of this very elongated economic recovery cycle. Under this scenario, any prospective Fed efforts to normalize interest rates would likely be quite modest; therefore, investors could easily rationalize and accept the normalization process.  

    Source: U.S. Bureau of Labor Statistics

In the coming year GMI Research will be looking for signals pointing to future path of U.S. core inflation, the consequences of which could have significant positive or negative consequences for risk-asset valuations and market volatility in 2015. 

Read the full Lookout Report here.

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