Tuesday, June 16, 2015

What will the Fed do this week?

The main event in markets this week is the meeting of the Federal Open Market Committee (FOMC).   The Committee can be expected to acknowledge the recent improvement in the data, leave rates on hold, but signal their preparedness to raise rates at some point this year.

Activity data is clearly on the mend with the Surprise Index now trending higher.  This supports the FOMC’s view that much of the weakness in in the first quarter was transitory.  The most recent and perhaps best bit of that story was the recovery in April retail sales which rose a better than expected 1.2% over the month.  The control group (the component of retail sales that feeds directly into GDP) was also stronger than expected telling us that second quarter GDP is off to a solid start.

Core CPI inflation is also looking firmer although much of that has been driven by the shelter component with core PCE lower than it was when the FOMC went all dovish on us in March.  Perhaps more importantly in terms of the outlook (market based) inflation expectations are on the rise again.

In terms of the labour market payrolls employment growth has improved after a quiet couple of months.  The month of May saw a return to solid employment growth with a jobs gain of +280k.  The annual rate of growth in average hourly earnings also ticked higher to +2.3%, still low by historical standards but a high for this cycle.  Most wage measures are now trending higher.  Forward looking data tells us the Committee can have some confidence jobs gains will remain solid in the months ahead with job opening trending sharply higher recently.

This meeting will also see the release of updated economic forecasts and interest rate expectations in the SEP ((Summary of Economic Projections) with the range and median of FOMC participant’s views captured in the now infamous dot plots.  It seems unlikely that we will see any significant shift in the dots this time around following the downward revisions to inflation and interest rates forecasts in March – at least not for the real economy (labour market, inflation or GDP growth).

Most attention will be on the interest rate dots where the Committee’s outlook has interest rates increasing at a faster rate than the market is current pricing.  There is therefore room for downward movement in the Committee’s expectations, especially if they want to reinforce the message from recent FOMC-member speeches that the pace of increase will be slow and, in the words of Stanley Fisher, closer to a “crawl” than a “lift-off”.   We still pick September for the first move.