We had several U.S. economic data points released this week, but the big news came from a source that is often just background information: the minutes of the Federal Open Market Committee.
In the minutes of the FOMC meeting of April 26/27, released on Wednesday, we see a key passage that has reset expectations about the path for short term interest rates this year. The passage reads, “Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s two percent objective, then it would likely be appropriate for the Committee to increase the target range for the fed funds rate in June.”
The fed funds futures market reset on the news. Currently, according to the CME Group, there is a 30 percent chance for a fed funds rate increase on June 15, well up from the previous odds at about eight percent. In our view, the futures market is slightly understating the odds, which we would place at around 40-45 percent. The Fed spelled out three requirements for a June rate hike. So far, economic data IS consistent with an increase in real GDP growth in the second quarter, versus the weak first quarter. Also, we expect labor indicators to remain consistent with strengthening conditions. A key test of that will come on June 3rd with the release of the May employment data, which we believe will show stronger payroll job growth than the weaker-than-expected 160,000 from April. Also, inflation indictors ARE already warming up with firmer crude oil prices. The consumer price index for April increased at a strong 0.4 percent rate, boosted by the 3.4 percent increase in the energy component.
In addition to the June 3rd employment data release, there are other important dates between now and June 15. On May 27, Janet Yellen will be speaking at Harvard and she could take the opportunity to clarify her position. Also, on June 6, Yellen is speaking in Philadelphia. That will be her last currently scheduled public event before the blackout week ahead of the June 14/15 FOMC meeting.
The Fed is also concerned about the potentially destabilizing impact of the June 23 BREXIT vote in the United Kingdom. Today, 33 days until the referendum, the Financial Times poll of polls shows 47 percent for STAY and 41 percent for LEAVE. Jean-Claude Juncker, head of the European Commission, fired a warning shot today, saying that “deserters will not be welcomed back with open arms,” perhaps not entirely helpful to the cause.
The FOMC’s vote on interest rates will come eight days before the U.K.’s BREXIT vote. The FOMC will not have a clearer crystal ball on that important issue than the rest of us. But, as of today, it looks like BREXIT will be a non-issue, and a non-disruptor of global financial markets. That could change if there is an event that significantly pushes British popular opinion over the next five weeks.
Even with no fed funds rate hike in June, the odds of two rate hikes this year have increased.
For a PDF version of the Comerica Economic Weekly, including forecast tables and the variables calendar, click here: CMAEconWeekly 05-20-2016.