The FOMC shocked the market this week when the minutes of the last meeting indicated a rate hike was possible in June. What they did not indicate was that a rate was definite, or even likely. Considering the fact that the Fed's official spokesperson, Janet Yellen, has said time and time again that all meetings should be considered "live" since the end of the Taper there was really nothing new in this report. Basically, the FOMC remains open to raising rates when it is deemed appropriate and is data dependent.
All quotes are from the Minutes Of The April FOMC Meeting.
participants generally saw maintaining the target range for the federal funds rate at 1/4 to 1/2 percent at this meeting and continuing to assess developments carefully as consistent with setting policy in a data-dependent manner and as leaving open the possibility of an increase in the federal funds rate at the June FOMC meeting.
Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee's 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June.
Their outlook, data dependent, is based on a big IF. If conditions continue to improve, it may be appropriate to raise rates in June... a sentiment hedged later in the minutes by this ....
Members generally agreed that, in light of the recent weak readings on spending and production, and with inflation below the Committee's objective, it would be prudent to wait for additional information bearing on the medium-term outlook before deciding whether to raise the target range for the federal funds rate
Admittedly, the headlines put forth by the general media make it seem as if a rate hike in June is a near certainty. However, the market does not agree. Based on the CME's Fed Watch Tool the chances of a June hike have only risen to 30%, up a mere 22% from earlier in the week. Looking past June, the Fed Watch Tool is only predicting a 55% chance of a rate hike in July, and just above a 60% chance in September.
The Labor Market Says Go
Labor data certainly supports a normalization of policy as it is running close to, if not at, the Fed's mandate of full employment. Non-Farm Payroll have been running at an average pace of +200K for more than the past year, jobless claims are running below 300K for the longest streak since 1973, job openings are running at/near the all time high, the quits rate remains strong and the both the participation rate and the employment to population rate have been edging up.
Many participants judged that labor market conditions had reached or were quite close to those consistent with their interpretation of the Committee's objective of maximum employment. Several of them reported that businesses in their Districts had seen a pickup in wages, shortages of workers in selected occupations, or pressures to retain or train workers for hard-to-fill jobs.
Based on the KC Fed's Labor Market Conditions Index the labor market is as healthy as it has been since before the financial crisis. The April report shows that activity in the labor market increased to 0.05 from 0.03 and that momentum increased from 0.48 to 0.62. This marks the highest level of activity since June 2008, with momentum trending near historic highs. Activity has been on the rise since early in 2010 and the recent cross into the positive territory more than just a statistical talking point.
source; KC Federal Reserve
Over the past 20 odd years a rise in the activity index above 0 from deeply negative levels has preceded both of the last economic booms in our country's history. The first was in early 1994, leading into the DotCom bubble, the second was in late 2003, leading into the Housing Bubble and Global Financial Crisis. Whether or not the current situation will lead to a massive bubble is yet to be determined, the take away being that labor market conditions are predicting a surge in economic activity sometime in the next 12 months.
Housing Markets Say Maybe
The housing market are not part of the Fed's mandate but as a substantial contributor to GDP and economic stability should be considered, especially since a rise in interest rates could have negative impact on the market going forward. The minutes themselves included 6 paragraphs, 10% of the total, discussing the housing market and it's affects on the economy and labor. While housing markets are generally higher this year than last year there is evidence of slowing and this could keep the FOMC from acting.
Recent information on housing activity was broadly consistent with a continued slow recovery in this sector. Starts and building permits for new single-family homes declined in March, but both measures were higher in the first quarter as a whole than in the fourth quarter of 2015.
Growth of residential real estate (RRE) loans on banks' books continued to be low through the first quarter, and credit conditions stayed tight for mortgage borrowers with low credit scores, hard-to-document income, or relatively high debt-to-income ratios
This is important to the Fed for another reason, employment. The housing sector has been one of the largest contributors to employment over the past year and its strength is relevant to the Fed's mandate of full employment.
According to the ADP report for April construction added 16,000 new jobs, nearly 9% of the total and the second slowest month of job creation in the sector for the past year. It is also the 5th month of slowing job creation in the sector and well below the 5 year average.
According to the NFP report only 1,000 new construction jobs were created in the month, the lowest level in over a year, down from the March high of 41,000 and well below last Aprils figure of 38,000. This data by no means says the Fed won't raise rates, but it certainly gives reason for them to wait for additional data.
Inflation Says No
April inflation data was definitely above expectations and is pointing to a gradual increase in interest rates but does not suggest that June is a definite. The hottest area of inflation is among consumer prices, up 0.4% for the month, but this is due primarily to increases in energy and gas, up 3.4% and 8.1% respectively. The core CPI, ex-food/energy, only rose 0.2% showing the effect of energy and gas on the headline number.
On a trailing 12 month basis CPI is only up 1.1%, well below the Fed's target rate of 2%. Core CPI is up 2.1%, not adjusted, over the past 12 months, in line with target levels and a mild concern, but is not strong enough to move the Fed to action on its own. Now, take into consideration the fact that core CPI has fallen over the past two months it appears that consumer level inflation is well contained, at least for now.
source; BLS Click to enlarge
Looking to producer level inflation the data is much softer. PPI only rose 0.2% in April on the headline number and is unchanged over the past 12 months. On a core basis, PPI ex-food/energy, prices rose only 0.3% in April and 0.9% over the past year. Neither number giving reason to believe a rate hike is coming at the next meeting, or even the meeting after that.
The staff's forecast for inflation was little changed from the previous projection. The staff continued to project that inflation would increase over the next several years, as energy prices and the prices of non-energy imports were expected to begin steadily rising this year, but inflation was still projected to be slightly below the Committee's longer-run objective of 2 percent in 2018
(click to enlarge) Source; BLS Click to enlarge
In addition, a number of participants judged that the risks to the outlook for inflation remained tilted to the downside in light of low readings on measures of inflation compensation and the fall over the past year in some survey measures of longer-term inflation expectations. Also, many participants noted that downside risks emanating from developments abroad, while reduced, still warranted close monitoring
The Risks As I See Them
There are two risks that I see at this time. The first is that the FOMC is notorious for acting too late, waiting too long to tighten and to loosen, and often exacerbates underlying problems in the economy. Because of this, and evidence of a slowing improving economy, they might choose to move earlier than strictly necessary, perhaps as soon as next month. Plus, there is still a fair amount of data due out between now and then which could change the entire outlook. The next meeting is scheduled for June 14-15, the FOMC will have entire cycle of labor and housing data to consider as well as another dose of PPI which is due out the morning of the policy decision.
The other risk I see is credibility. The FOMC has been talking the market up and down for over a year, first targeting employment and then moving to other data once the employment picture appeared to have stabilized. Along the way the voting and non-voting members have increased market volatility with views and opinions that contradict each other and the greater FOMC policy/stance. This has culminated in the most recent meeting and minutes release in which the policy gave no hint of a June rate hike while the minutes seem to point to at least an active discussion of one. If they continue to twist in the wind they run the risk of further damaging credibility and their ability to impact the economy through statements.
Some participants saw limited costs to maintaining a patient posture at this meeting but noted the risks--including potential risks to financial stability--of waiting too long to resume the process of removing policy accommodation, especially given the lags with which monetary policy affects the economy. A couple of participants were concerned that further postponement of action to raise the federal funds rate might confuse the public about the economic considerations that influence the Committee's policy decisions and potentially erode the Committee's credibility.
Will The FOMC Raise Rates In June?
So, will the FOMC raise rates in June? My answer is a big fat maybe. The data certainly points to the eventual need, some more so than others, but there is no one piece that says it is definitely necessary, and the aggregate leaves lots of room to maneuver.
a number of participants judged that it would be appropriate to proceed cautiously in removing policy accommodation. Some participants pointed to the risk that the recent weak data on domestic spending could reflect a loss of momentum in the economy that might hinder further gains in the labor market and raise the likelihood that inflation could fail to increase as expected.
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