As new jobs mount, Fed may tighten more than markets are pricing in

Published: Dec 5, 2014 1:48 p.m. ET

GREGROBB

SENIOR ECONOMICS REPORTER

Federal Reserve Board Chairwoman Janet Yellen

WASHINGTON (MarketWatch) — Ever since the financial crisis, many Wall Street bullies have picked on the Federal Reserve for coddling investors and being afraid to let markets work.

Don’t look now but the “98 pound weakling” is looking a lot more menacing these days. With the labor market looking so vibrant, the U.S. central bank could preparing to take rates higher than many forecast.

“The strength of the U.S. labor market simply reinforces our view that the Fed will be raising the federal funds rate sooner and more aggressively than widely expected,” said John Higgins, chief markets economist at Capital Economics.

The labor market added 321,000 jobs in November, according to the Labor Department. That’s the strongest pace since 2012.

As a result of the stronger-than-expected data, financial markets moved their estimates of the first rate hike earlier, to July, from prior estimates of later in the third quarter. But what the market may not be doing is correctly pricing how high interest rates will go.

Fed fund futures are pricing in interest rates of 1.6% at the end of 2016.

Eric Green, head of U.S. rates and economic research at TD Securities, said that the Fed might be more aggressive than expected.

“This is not a kindler and gentler Fed,” he said.

Green pointed to a speech earlier this week by William Dudley, the president of the New York Fed, and a close ally of Fed Chairwoman Janet Yellen.

“When the Fed tightens, Dudley made it painfully clear the Fed expects monetary conditions to tighten accordingly, and volatility to rise,” Green said in a note to clients.

In his speech, Dudley stressed the Fed would not repeat the slow and steady pace of the Fed’s last tightening cycle launched in 2004 when former Fed Chairman Alan Greenspan launched a “measured, monotonic pace,” of rate increases, Green noted.

“It suggests the Fed may move even more aggressively if needed to achieve the desired tightening in financial conditions,” Green said.