Economy: Hawks Will Fly - A Wakeup Call For The Federal Reserve

(Drivebycuriosity) - Last week the Federal Reserve got a wake up call, maybe more than one. Janet Yellen & Co. refused to hike interest rates in their September & October meetings because they worried about a soft spot in the US economy and a cooling global economy. They also feared that further falling oil prices could lead into a deflation (downward pressure).

Last week the fears - and so the arguments against a hike - got crushed.  Friday´s strong US labor report signals a solid economy: The US economy added 271,000 jobs in October, the unemployment rate dropped to 5%, its lowest level since 2008, and wages grew at their fastest pace since mid-2009 (businessinsider).

Last week we also learned that the US service sector - the engine of the economy - accelerated its growth last month: "The October ISM Non-manufacturing index was at 59.1%, up from 56.9% in September. The employment index increased in October to 59.2%, up from 58.3% in September. Note: Above 50 indicates expansion, below 50 contraction" (calculate). And the global economy is stabilizing: Recently Europe reported better manufacturing & services data and China´s service sector accelerated its growth as well (marketwatch).

The fears about deflation also are unwarranted: On Friday oil (brent crude, the international oil gauge) closed @ $48, about $2 above the low from January ($46.59). So, since January oil didn´t get any cheaper! (bloomberg). The downward pressure had already disappeared in the recent months! It seems that the oil price is sticking close to the $50 mark bolstered by reports about a shrinking US oil production. Meanwhile the basic inflation rate is advancing. The US core inflation rate (without food & energy) advanced in September to 1.9% (August 1.8%), driven by climbing rents and more expensive services, especially rising health care costs.

A zero interest rate doesn´t fit into a growing economy. It is likely that in the coming months the tightening labor market will drive wages and therefore labor costs upwards which should translate into higher prices for services and labor intensive goods. And we are already experiencing rapidly climbing rents and health care costs. Zero interest rates for too long could lead to an overheating labor market and will push the core inflation rate higher.  In December the Fed will have the chance to correct her mistake and adapt her interest rates marginally to a better economy.