Fed to hike in September?

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From Westpac’s excellent Elliott Clark:

1The release of FOMC meeting minutes is an opportune time to reassess and update (if necessary) our expectations regarding monetary policy. Not only does this document typically provide clear guidance on the degree of consensus amongst members, it also outlines key macroeconomic trends in the minds of the Committee.

In this instance, what is most critical is gauging the degree to which the weakness apparent in Q1 is transitory. Committee members clearly believe that this is the case, highlighting a number of reasons in support: the “severe winter weather”; the West Coast port strike; and abnormal seasonality, with “a pattern observed in previous years of the current expansion… that the first quarter of the year tended to have weaker seasonally adjusted readings on economic growth than did the subsequent quarters”.

2From the tone of the minutes, it is clear that Committee members do not expect growth to rebound on support from investment; net exports; or government spending. On investment it was noted that “forward-looking indicators… were generally consistent with only small further gains in the near term”. And on net exports, while the West Coast port strike was blamed for weaker imports, the discussion around exports was more general, “with exports to Canada and China accounting for most of the drop”. Herein it is clear that the impacts of the weak oil price and strong US dollar are expected to persist. For exports, uncertainty over the strength of global growth adds an additional measure of angst.

What is alluded to above was made clear elsewhere in the minutes: that “Some participants… expectations of a moderate expansion of economic activity in the medium term, combined with further improvements in labor market conditions, [rest] largely on a scenario in which consumer spending grows robustly despite softness in other components of aggregate demand.” All the more so, given the “recovery in the housing sector remain[s] slow”, the strength in aggregate demand depends on household consumption.

3The Committee’s expectation of a bounce back in consumption and aggregate growth is founded on the fact that a “number of the fundamental factors that drive consumer spending [remain] favorable”: interest rates are low; consumer confidence is high; job gains continue with the unemployment rate at or near full employment; and, boosted by the sharp decline in the price of oil over the past year, real household incomes have risen robustly.

Yet apparent in recent retail sales data, as highlighted in the April FOMC minutes, is cause to doubt if these significant positive factors will boost consumption, in scale and/or timing, as expected. At this juncture, there is clearly hope but not proof.

The consequence of the above trends for near-term policy is that while a “few anticipated that the information that would accrue by the time of the June meeting would likely indicate sufficient improvement in the economic outlook to lead the Committee to judge that its conditions for beginning policy firming had been met… Many participants… thought it unlikely”. This points to September remaining as the most likely starting point for rate normalisation.

4We remain of the view that the September meeting will see the first rate hike and that another will most probably follow in December,with only a brief ‘data’ window in between. Where the risks lay is in the outlook for 2016. To see our expectation of four further rate hikes come to pass will necessitate a broadening of growth from consumption to investment (residential and business) and further job and wage gains as a result. With the global economic backdrop proving challenging, domestic demand growth is key.

I’ve got lot’s of time for Mr Clark but this is overly hawkish on balance. The US consumer is not rising to the challenge and hoping s/he will flies in the face of the past five years. That said, the grind up will go on, led by inflated asset markets, so the Fed has to wait until it sees the white of inflation’s eyes. Even then, given the entire model is now asset price led, a few hikes will be enough to bring it all down so four hikes is a cycle-ending forecast. The US dollar will also rise as the Fed tightens so I still say two slow hikes during next year and when the third comes duck!

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.