Global Daily – Fed hike approaching

by: Maritza Cabezas , Nick Kounis

Global-Daily-Insight-20-August-2015.pdf (56 KB)
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  • The Minutes of July’s FOMC meeting indicated that conditions for a rate hike are approaching.
  • Rate rise depends on sustained economic growth and “some” improvement in employment.
  • Strong US economic data after FOMC meeting suggest rate hike in September still on the cards.

 

 

Conditions approaching, but not yet there

The minutes of July’s FOMC meeting suggested that most members thought that conditions for a rate hike had not yet been achieved, but they were approaching that point. Participants were optimistic about the improvement in the labour market, but many saw scope for some further improvement. Many participants said that “sustained economic growth and further improvement in the labour market was key in supporting their expectation that inflation would move up to the Committee’s 2% objective.

 

Fed’s preparation for the rate hike

The Fed has been preparing markets for a rate hike this year. A delay could have counterproductive effects for the economy. Participants noted that “a prompt start to normalization would likely convey the Committee’s confidence in prospects for the economy”. Some nuances were discussed around the Fed’s data dependency. Some participants advised that data be viewed in light of the cumulative gains made to date, without overemphasising month-to-month data. Regarding the communication, it was noted that emphasis should be made of the path for policy and not the initial increase. In their discussion of the appropriate path, a gradual path was the preferred option to ensure that the economy can absorb higher rates.

 

Strong US economic data after July’s FOMC meeting

Economic data are taking outsized importance in shaping investors views on the timing of the upcoming Fed rate hike. Since the last meeting the economy has been showing signs of strong fundamentals. The last labour market report was strong. Nonfarm employment increased by 215K in July. Job gains above 200K are a sign of a strong labour market, while the unemployment rate is now at 5.3%. As a result slack is diminishing. The impact of the labour market is slowly filtering through to the economy. Retail sales rebounded strongly in July, with upward revisions to June’s sales. Demand for housing is increasing and as a result the US housing market is picking up momentum. This all adds to the picture of an economy growing at above trend rates.

 

US inflation to rise to 2% target in the medium term

July’s inflation report, released yesterday showed that core consumer prices increased 0.1% down from 0.2% the previous month. This left them up by 1.8% yoy. A sharp fall in air fares depress core inflation in July, while the effects of the strong dollar were visible in weak core goods prices. Meanwhile, shelter (rental prices), which comprise a relatively large share of core inflation (around 42%) are pushing up inflation. A higher demand for rental properties is exerting pressure on rental prices. This is likely to continue and we expect core inflation to gradually firm during the year as diminishing slack also puts upward pressure on inflation. This would support the Fed’s view that inflation will rise gradually to 2% over the medium term as the transitory effects of declines in energy and import prices gradually dissipate.

 

Rate hike in September

We expect “some” further improvement ahead as the gains in the job market continue to support the economy. This is what the Fed wants to see before a rate hike. Consequently, a rate hike in September remains very likely in our view. Tighter financial conditions will, however, lead the Fed to opt for a significantly slower pace of rate hikes compared to past cycles.