Markets have been shocked by the apparent hawkishness of the April FOMC minutes which indicated June is well and truly “live” for a rate hike. Interest rate markets had priced in virtually no chance of a June rate increase with that probability having jumped to 30% since the minutes were released. That seems to us to be an appropriate representation of the odds.
Our view has been that a June hike was unlikely unless we see some significantly better data following the weak March quarter. The data since the April FOMC meeting has been OK - on average. The April CPI came in higher than expected and April retail sales showed a pleasing bounce. That result supports the case that March quarter weakness was temporary.
April payrolls data was softer than expected but we are open to the possibility that this is a sign of a tightening labour market (see post below). Contradicting that, however, is the recent lift in jobless claims.
On balance we think June quarter GDP growth is likely to come in at around a 2% annualised pace, so not the usual strong above-trend bounce we have been used to seeing after weak March quarter data over the last few years.
So that leaves us thinking there is still sufficient uncertainty about growth and more specifically the degree of slack in the labour market to make a June hike unlikely but still possible, so a 30% probability appears about right. That’s reinforced when considering the Fed’s new unofficial third mandate of global economic and financial stability. Markets are currently rerating US interest rate expectations and the Fed may feel that’s enough for now.
The key point we need to take from the minutes is that the US Federal Reserve is determined to push on with the normalisation of interest rates and all that is up for debate is the pace and the eventual end point. Markets had gone too far in pricing virtually zero chance of a hike in June.
What’s changed for me is that regardless of whether the Fed hikes in June or not, the probability of two hikes before Christmas has gone back up. I had thought that if they didn’t go in June that September was the next most likely opportunity and that if that was the case, only one hike was likely this year. But July is now a distinct possibility, especially if the only thing holding them back in June is potential market volatility around the “Brexit” referendum. Data will clearly still be important with the most critical being May payrolls released in early June.