Fed: Caution in June

Published on June 13, 2016

Key takeaways:
The dismal NFP and the rush into safe haven treasuries has taken a rate hike off the June table, but the FOMC majority will still want to keep its options open for a hike in July.

The 2016 rate dots will come down but the median is likely to stay at two hikes, while the 2017 and 2018 rate dot plots should likewise move lower but look more elongated due to differing views on inflation. 

Potential Brexit aftershocks, renewed yield compression, and lower inflation expectations will lend a cautious tone to Chair Yellen’s press remarks, steering clear of near term guidance. 

The first thing that could be said about this week’s meeting of the Federal Open Market Committee is that few if any of its members thought this is where things would be by the time they sit down around the big table tomorrow morning.


Right up to the dismal optics of that most recent Non-Farms Payroll print, a solid majority of the FOMC were favoring a rate hike this “summer,” possibly this week, with most leaning to July out of a sense of caution (SGH 5/27/16, “Fed: Appropriate Behavior”). But that was a life time ago.


A few notes on our expectations for this Wednesday:


*** Despite the NFP disappointment, the near term base case forecast going into this week’s meeting is for growth, even if lowered slightly this year, to still be just enough above a lowered trend to continue tightening the labor market that, in turn, still underpins the presumption for an eventual rise in inflation. Against that forecasting backdrop, a Committee majority is likely to still want to keep their options open for a “dovish hike” at the late July meeting. ***


*** That said, potential Brexit aftershocks, the renewed compression of term premiums and near record low yields, and Friday’s decline in inflation expectations, despite higher gasoline prices, will all lend a cautious tone to Chair Janet Yellen’s assessments of the near policy outlook in her post-meeting press remarks. Indeed, she is likely to shy away from any near calendar-specific guidance in otherwise laying out the case for an ever gradual policy normalization strategy that still stands. ***


*** The rate dot plot may do some of the July messaging work for the FOMC in that the median for the 2016 rate dot projections is likely to remain at two hikes, with too few dots lurching lower to bring the median down to a single rate hike. The 2017 and 2018 rate projections should likewise come down, but look more elongated with differing views on inflation keeping some rate dots nearly as they were in March. The longer run neutral rate projections are likely to see more dots dropping below 3% and none at 4% or higher. ***


A Change in Communications


Perhaps the most important takeaway from the outcome of the FOMC June meeting on Wednesday may be a change in the FOMC’s communications tact on its near term policy outlook.


It was no small source of frustration for Fed officials to have been coalescing around a consensus for a second rate hike this “summer” and to have ramped up the policy messaging for several weeks across May, only to have it shattered by the unexpectedly weak employment number. The surprisingly weak University of Michigan survey of five year inflation expectations only adds to the frustration – and to a renewed sense of caution.


Thus, it will be important to see how carefully Chair Yellen is able to strike a balance in her press remarks between the Fed’s relatively upbeat base case path for the upward direction of rates that lies at the heart of the policy normalization strategy, versus the caution amid the present market storms and political uncertainties. Chair Yellen will probably want to steer clear of an excessively dovish takeaway from the June meeting outcome, but she is almost certain to religiously avoid giving any sort of calendar-specific signal on when that next rate hike is coming. Been there, done that.


It was widely noted how Chair Yellen judiciously passed on any repeat reference to “coming months” in her June 6 speech in Philadelphia, but the more important takeaway from her speech was the string of questions she poised at its end, that in essence, is the Fed’s near term reaction function to the data in, well, the coming months and thus the best marker that will be available to the tactical timing on its next rate move.


Discerning whether the slower pace of job creation in April and May was a sign of a slowing economy or a dip in an otherwise steady job growth laid out in the forecast will put an obvious premium on the next NFP print; likewise, there will be a watchful eye on any sustained upward wage measures to gauge whether the slower job creation, coupled to the drop in the labor participation rate, is evidence of less slack in the labor market than currently assumed.


Add to that the concern Yellen highlighted in her Philadelphia speech about falling inflation expectations — which is exactly what bore out in Friday’s University of Michigan survey — and taken together, we suspect these criteria may in effect shape the contours to the Fed’s policy messaging going forward on the timing to that next rate move.

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