The timing of the US Federal Reserve’s first interest rate hike in almost 10 years has been the subject of much debate this past 7 months. Our take – a rate hike in September 2015 is very much on the table especially given the release of the latest US jobs report last Friday.

Broad based gains were noted in the US labor market with 215,000 jobs added in July. The unemployment rate (U3) fell to a 7 year low of 5.3% but the most noteworthy feature here is that the gap between the U6 and U3 numbers continues to narrow. The U6 rate includes workers who work part-time purely for economic reasons (i.e., they cannot find full time jobs) while U3 is the official unemployment rate in the US. According to the US jobs report, U6 fell to a 10.4% reading, the lowest since June 2008. This “underutilization of labor resources” is a key measure monitored by US Federal Reserve Chair, Janet Yellen.

This latest jobs report, together with 2nd Quarter GDP growth of 2.3% and the uptick in the FOMC’s key inflation indicator (PCE) and personal consumption, sets the stage for a September 2015 hike in the Federal Funds rate. The question is – are global financial markets adequately prepared for the consequences of this policy action? The close last Friday (7th August) for VIX (13.39) and yield on the US 10- year Treasuries at 2.16% suggest that financial markets are still complacent about the potential fallout from this key policy reversal.

Global asset markets, powered by a flood of liquidity (recall the US$9 trillion carry trade?), have been the key beneficiaries of the US Federal Reserve’s ultra accommodative monetary policy. The switch to a less radical, tighter policy stance will lead to investors re-thinking the accessibility of low cost funding, the resultant impact on global growth and finally, equity valuations. If financial markets are not positioned for this first rate hike by the US Federal Reserve, a violent knee-jerk reaction is a real possibility.

Tactically, we favor VIX calls; short DM and EM equities through listed ETFs; long puts on S&P500 Index; short oil through listed ETFs; and long puts on US 10 year Treasuries.

Are you ready for lift-off?

© Jachin Capital Pte Ltd

UEN: 201419754M

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