U.S. Bond Market Week In Review: A Late In The Year Rate Hike Is Probably Back On The Table

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On Wednesday, the Federal Reserve released the minutes from its June 14-15 meeting. As always, this document provides a comprehensive overview of the current state of the U.S. economy. A majority of the discussion centers on coincident indicators, which are depicted below:

The above chart plots industrial production, total payroll employment, trade and manufacturing sales and total income less transfer payments on a base 100 scale dating from June 2009, which, according to the NBER, is when the recession ended. Industrial production (red line) is the only number declining; the other three are rising. The Conference Board provides another perspective on the coincident numbers:

The top table shows the month-to-month increase in the CEIs, while the bottom table shows a rolling 6-month average. Monthly gains have been minimal for the last 7 months, while the rolling average shows a consistent rise of .7-1%. According to the Conference Board's analysis of the data, these readings show that "economic activity should continue at a moderate pace in the near term, but risks for a slower growth outlook may be rising." The Fed's analysis is slightly more bullish, as represented by the Atlanta Fed's 2.4% projection and the NY Fed's 2.1% forecast.

At the meeting, the Fed discussed all major economic sectors, starting with personal consumption spending. Participants observed that consumer spending, which is responsible for 70% of economic growth, was increasing due to rising wages, the "wealth effect" of rising equity and real estate values and solid employment growth. They specifically discussed personal consumption expenditures:

The purple bar at the far right of each month represents the total monthly increase in PCE spending from the preceding month. Overall spending increased in all but 2 months. The Fed believes this trend will continue due to strong consumer balance sheets, positive sentiment and rising incomes.

In contrast to PCEs, business investment is declining:

Non-residential building investment (green) has been contracting on a Y/Y basis since 1Q15; business investment (blue) contracted in the latest quarter, while intellectual property investment is still positive. The Fed noted that while the oil & gas slowdown started the decline, the weakness has now spread to other business sectors. The decline in industrial production is also contributing to the drop. The outlook for this economic sector is mixed.

The housing market, whose bursting financial bubble was a contributing factor of the Great Recession, is doing very well:

The top chart shows building permits (blue line) and housing starts (red line), which have clearly rebounded from their post-recession lows and are now moving sideways between a 1 million and 1.2 million annual pace. The bottom chart shows that new homes (red line) are in a short-term trend that started in September 2015, while existing home sales (blue line) have printed at a consistent pace. Low bond yields, which are a side effect of the post-Brexit flight to safety, should translate into lower mortgage rates, which should help increase housing demand in the near future.

The Fed was very concerned about May's weak employment number, but took a wait-and-see attitude to determine if it was the beginning of a downward trend in the data. Friday's very positive report indicated it probably wasn't, as the headline number of 287,000 put to rest fears of an employment slowdown caused by May's paltry 38,000 growth rate. All the gains came from the private sector, where total jobs increased 256,000. Increases were widespread: information services (+44,000), retail trade (+29,000), temporary help (+15,000) and professional services (+38,000) all contributed. The participation and employment rates were unchanged. While total hours worked were unchanged, earnings rose 2.6%. This release indicated that May's report was most likely an outlier in the data.

What does this mean for Fed policy? The Minutes contained the following information:

Members generally agreed that, before assessing whether another step in removing monetary accommodation was warranted, it was prudent to wait for additional data regarding labor market conditions as well as information that would allow them to assess the consequences of the U.K. vote for global financial conditions and the U.S. economic outlook. They judged that their decisions about the appropriate level of the federal funds rate in coming months would depend importantly on whether incoming information corroborated the Committee's expectations for economic activity, the labor market, and inflation. Some of them emphasized that, with labor market conditions and inflation at or close to the Committee's objectives, taking another step in removing monetary accommodation should not be delayed too long. However, a couple of members underscored that they would need to accumulate sufficient evidence to increase their confidence that economic growth was strong enough to withstand a possible downward shock to demand and that inflation was moving closer to 2 percent on a sustained basis.

Just as the Fed didn't want to overestimate the impact of May's weak employment numbers on its interest rate calculus, so too will it probably take a wait-and-see attitude on June's impressive headline numbers. The BEA reports the advance estimate of GDP on July 29th, two days after the Fed's July meeting, implying that the Fed will probably wait until September to raise rates, giving it two more employment reports and additional GDP data on which to base its decision.

Hale Stewart, XE.com