Of course I was wrong.
Back in March, I said that the market was getting the Fed wrong and that a June rate hike was very much on the table.
The basic argument was that while the Fed said the labour market still had a ways to go for the economy to reach “full employment,” recent data (to that point), had suggested we could still reasonably expect the job market to beat expectations.
And then we got the March jobs report, which was a dud.
Then April’s report was fine, but not a blowout report that totally changed the Fed’s outlook: after that report it was more or less clear June was off the table.
In its April policy statement, the Fed said it anticipates, “it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labour market and is reasonably confident that inflation will move back to its 2 per cent objective over the medium term.”
Basically, the Fed said it will be “data dependent.” And the data, so far, are not giving the Fed reasons to change course.
Right now, consensus among Wall Street’s economics community is that the September or December Fed meetings are when the Fed will want to raise rates for the first time in over 9 years (the last Fed rate hike was in July 2006).
The US economy’s performance this year, however, doesn’t look all that encouraging. Wall Street has taken its expectations for the next estimate of first quarter GDP to show that the economy contracted by somewhere around 1%. And with the Atlanta Fed’s GDPNow tracker indicating that the economy is on pace to grow 0.7% in the second quarter, the economy overall may well have gotten smaller in the first half of the year.
And while the Fed’s April statement indicated the the Fed, on balance, sees the economy’s negative performance as “transitory,” or passing with time, there was considerable attention at the meeting paid to the idea that maybe this weakness won’t pass.
Here’s the Fed:
Various reasons were also advanced for believing that some of the recent weakness in the pace of economic activity might persist. A number of participants suggested that the damping effects of the earlier appreciation of the dollar on net exports or of the earlier decline in oil prices on firms’ investment spending might be larger and longer-lasting than previously anticipated. In addition, the expected boost to household spending from lower energy prices had apparently so far not materialised, highlighting the possibility of less underlying momentum in consumer expenditures than participants had previously judged. Some participants expressed particular concern about this prospect, as their expectations of a moderate expansion of economic activity in the medium term, combined with further improvements in labour market conditions, rested largely on a scenario in which consumer spending grows robustly despite softness in other components of aggregate demand.
And what’s more, Wednesday’s minutes indicate that the Fed isn’t just looking at the US when evaluating the economic landscape, but clearly keeping an eye on developments abroad.
Here’s the Fed’s global outlook:
In their discussion of the foreign economic outlook, several participants noted that the foreign exchange value of the U.S. dollar had fallen back somewhat over the intermeeting period. Nonetheless, the value of the dollar had increased significantly since the middle of last year, and it was seen as likely to continue to be a factor restraining U.S. net exports and economic growth for a time. It was suggested that one element underpinning the strength of the U.S. dollar was the increasing prevalence of negative interest rates on sovereign debt in some key European economies. Participants also pointed to a number of risks to the international economic outlook, including the slowdown in growth in China and fiscal and financial problems in Greece.
And so while the Fed’s mandate is full employment and price stability — which right now means an unemployment rate of around 5% and inflation at around 2% — the Fed also seems reticent to unsettle financial markets by moving too soon.
“Financial stability” is a term that has come up a lot from Fed members of late, and in the Minutes, the Fed addresses this concept at some length, writing:
However, some indicators suggested that valuations remained stretched for some asset classes. An estimate of the expected real return on equities moved down, reflecting an increase in stock prices and downward revisions to forecasts of corporate earnings, and corporate bond spreads declined somewhat. The staff also noted changes in the structure of some fixed-income markets that could increase volatility. In addition, the staff discussed the risks to financial stability associated with the possibility of substantial unanticipated changes in longer-term U.S. interest rates, including the scope for a sharp increase in such rates to affect financial conditions in emerging market economies. A number of other risks were noted, including geopolitical tensions and the potential for an increase in financial strains related to the negotiations between Greece and its official creditors.
What all this amounts to, of course, is, again, that I was wrong.