• A Fed messaging offensive is underway, culminating with Chair Yellen’s twin speaking engagements on May 27 and June 6, to move market pricing higher for a June rate move.
• Indeed, recent data has been supportive of the strong FOMC lean towards a June hike, which is also likely to be evident in the April meeting Minutes released tomorrow.
• July is a lower odds fallback option, with Brexit seen for now as a low risk. But a rate increase by September is highly likely.
May 17, 2016
It would seem Federal Reserve Chair Janet Yellen has heeded numerous suggestions from both within and outside the central bank that she should offer more public remarks and speeches to clarify the Fed’s policy approach and reaction function.
Just in the last week or so, it was announced she will not only be speaking at a Harvard University luncheon on May 27, but yesterday it was confirmed she will also give a speech in Philadelphia on June 6, quite literally on the very eve of the pre-June meeting communications black out; that speech before the World Affairs Council will also come three days after the May Non-Farm Payroll numbers are released that Friday.
*** Chair Yellen’s scheduled remarks will in fact mark the culmination of what has been something of a concerted Fed communications offensive underway in earnest since last week to push market pricing to a significantly higher probability for a June rate hike. Indeed, while not entirely certain, we think the odds on a second rate hike in the policy normalization path as soon as the Federal Open Market Committee’s June 14-15 meeting are better than even. ***
*** Uncertainty over the outlook left the FOMC hesitant to commit in its April statement as firmly to a rate move in June as they did in October last year to December’s rates lift-off. But recent data have been supportive of the forecast for at least 2% growth this year that should continue to tighten the labor market and lend to further confidence in a rising inflation. The April meeting Minutes tomorrow are also likely to read relatively hawkish, further reinforcing the June messaging. ***
*** The main constraint on a June rate move is really the extremely low market pricing, barely 8% at present. Fed officials, however, are reasonably confident a consistent messaging, especially from the Chair herself, could lift those odds to better than even, which would provide the minimum backdrop to a rate move with limited dislocation. That said, Brexit volatility notwithstanding, a rate move at the July meeting also seems to be a lower probability fallback. ***
Supportive May Data
The softer than expected data through the first quarter and a nagging uncertainty whether the May data would display enough clarity on the forecast created some messaging complications for the Fed in preparing a long runway to a near term rate move. For one, it precluded using the April meeting statement to strongly signal a likelihood of a June rate move. Scaling back the global risk sentence was meant to at least keep the door open to June.
The marking down in recent weeks across the Fed system in the assumed trend growth to 1.5% to maybe 1.75%, and a sense the barely positive real neutral rate may persist for longer than previously assumed (see SGH 4/5/16, “Fed: Burden of Proof”) only added to a sense of a fading probability for a June move.
The data ever since the beginning of the month, however, has consistently been to the upside of expectations and wholly in line with the base case forecast of the Fed for growth north of 2% this year. Set against the lower trend growth, that should be more than enough to continue tightening the labor markets and in turn bolster the Fed’s confidence in its projection for inflation to slowly rise through the year, especially if the dollar and oil base effects do drop out of the data as expected.
The April NFP, for instance, while initially seen by the markets as disappointing, was instead seen by most Fed officials as still within the forecast projections. The number of net new jobs did decline, but then the pace of job creation was expected to be easing down as it would be near impossible to find 200,000 workers a month when the unemployment rate was down to 5% or less.
What’s more, the breakeven for removing labor market slack in most Fed estimates is between 85,000 to perhaps 120,000 a month. Whatever let down Fed officials may have felt about the NFP was more about the way it was interpreted by the markets than the signals in the NFP numbers.
So for the Fed, the labor market should continue to tighten as long as growth stays in line with the forecasts for 2% or better through this year. And on that front, despite the concerns personal consumption in the first quarter was running a bit below even the lowered projections amid a soft first few months, the numbers to date in May like Friday’s solid retail spending figures have clearly helped to boost the Fed’s confidence in the forecast.
Retail sales rose by a very healthy 1.3 per cent compared to March, driven by income gains and continued job creation, while the prior two months were revised up, which should portend well for a healthy looking second quarter real PCE. The University of Michigan’s consumer sentiment also jumped to an 11-month high of 95.8, and the important longer term inflation expectations index rose a tenth to 2.6%. Reflecting the stronger looking second quarter, the Atlanta Fed’s GDP Nowcast estimate for the second quarter growth most recently stands at 2.5%.
And the CPI and the Industrial Production prints this morning were both stronger than expected, and fit into the same May data frame of the expected rebound in economic activity.
As though right on cue, the Fed messaging in the last week marked a distinctive turn to a more hawkish stance. Among the recent speeches and remarks by Fed officials last week, the one that stood out were those by Boston Fed President Eric Rosengren, who though dovishly leaning, made a point of warning the market is seriously underpricing the strength of the US economy and the probabilities for a June meeting rate move.
And we suspect the April meeting Minutes that will be released Wednesday afternoon will read relatively hawkish, which should tend to underpin the messaging currently in motion to shift market expectations.
This Thursday morning, Vice Chair Stan Fischer will be giving a keynote speech to open a conference at the New York Fed, while later that same day, its president Bill Dudley will be briefing the press. The tone and thrust of his remarks will be closely watched as something of a set-up and hand-off in the Fed messaging to Yellen’s two step likely signaling about the near term policy path in Cambridge and Philadelphia a week from Friday and then the first Monday in June.
If the Fed messaging is indeed to push the market to a much higher probability in its pricing for the June meeting, it is admittedly a short runway of just a few weeks, compared to the longer run-up to the December first rate hike from the signal inserted into the October meeting statement.
But it should be more than enough for short rate positions to be adjusted, which in any case after being burned so many times previously, are unlikely to move in size until the Chair indeed confirms a hawkish Committee lean going into the June meeting.