For a while, markets were confident the Fed would begin tightening monetary policy with an interest rate hike in September.
On Wednesday, we got the minutes from the Federal Reserve’s July meeting. The details put out a mixed assessment of the economic conditions necessary for the first rate hike in a decade.
And now, after relative confidence that it could be next month, markets are getting more doubtful about the idea that the Fed will liftoff at its next meeting.
The FOMC said the economy is nearer to the conditions necessary for a rate hike, which, at face value, is a bullish signal. They added that even though there’s still slack in the labour market, it is nearing the conditions necessary for maximum employment.
However, its inflation target continues to be elusive, thanks to lower oil and import prices.
Also, the Fed brought up China. It is worried about the possibility of a spill over from weakness there, although it noted that the impact has been muted so far. It’s worth noting that the meeting happened before China started devaluing the yuan in a bid to stimulate the economy.
And so, as Deutsche Bank’s Jim Reid wrote in his morning note to clients on Thursday, the minutes left markets “slightly lost, upset and confused”. The Dow lost as many as 200 points in morning trade yesterday, rallied well off the lows after the minutes, and tumbled right back in the afternoon.
The market isn’t sure how to interpret the Fed’s minutes, and fewer people are betting on September.
Here are Bank of America Merrill Lynch economists in a note to clients on Wednesday (emphasis added):
“The Committee seemed much more evenly divided than earlier minutes and speeches might have suggested. The FOMC has not ruled out September, but now the incoming data need to support a hike rather than merely not strongly argue against it. The July minutes have significantly increased the uncertainty going into the next FOMC meeting, and leave us with a very close call for September liftoff.”
BNP Paribas’ economics team also came out of Wednesday quite bearish on next month, noting to clients that the minutes “severely damaged the chances of rate lift-off in September.”
They wrote (emphasis added):
“It is unlikely that upcoming data would be sufficient to deliver the requisite degree of confidence in the inflation outlook in time for a hike in September — there’s just not enough runway. A mammoth payrolls, a sharp fall in unemployment and a spike in average hourly earnings could yet resurrect lingering hopes of September, but we see this as unlikely. ”
And here’s BAML:
“The minutes from the July FOMC meeting were so dovish that they appear to better reflect the post-meeting deflationary developments in August, although we are told the Fed ensures they accurately reflect the actual discussions at the meeting. Regardless we have to respect the decline in the market-implied probability of September liftoff to about 30% from around 50%.”
This chart from BAML shows that market expectations for a September hike plunged on Wednesday, after rising to about 50% before the minutes dropped.