Commerzbank:
Fed: How high is the bar to a rate hike in June? A majority on the Federal Open Market Committee wants to raise interest rates in June if economic data has improved by then. This was evident in the minutes of the April meeting that were released on Wednesday. We analyse how high the bar to a move in June is likely to be. All in all, we still believe the Fed is more likely to continue waiting. But there is a considerable risk that a rate hike is imminent.
The minutes of the April FOMC meeting mentions three criteria that must be fulfilled for a rate increase in June: 1. Economic growth accelerates in Q2 In April, several FOMC members were still concerned that the weakness in Q1 could last longer. But “hard” indicators have mostly surprised on the upside since then. Firstly, the data suggest that the US economy did not perform quite as poorly in Q1 as previously assumed, and the GDP growth rate should be revised upwards from 0.5% (annualised rate) to 1.0%.
Secondly, there is increasing evidence pointing to considerably stronger growth in Q2: Retail sales indicate that private consumption has regained much momentum. In April, real consumption expenditure likely rose by 0.5% versus March, which would be the largest gain since May 2015, and the increases reported for February and March will probably be revised upwards (see chart 3).
Moreover, housing starts and building permits have recovered from the decline in March, and industrial production also rose noticeably in April. 2. Labour market continues to grow firmer The April employment report was quite convincing, and the report for May, which is due before the next FOMC meeting, should also point to further labour market recovery. But in the past, Fed officials often cited individual labour market aspects, such as the number of involuntary part-time employees, as evidence of supposed weakness.
This time round, the unemployment rate could play this role, where the decline has come to a standstill in the last six months. 3. Inflation makes further progress towards the Fed’s 2% target The consumer spending deflator excluding energy and food, the Fed’s preferred inflation measure, rose only slightly in March (chart 4), which means that the elevated inflation pressure seen at the start of the year has proven to be an outlier as Fed chairwoman Yellen had assumed. At the same time, available data on April consumer prices gives reason to expect a sharper rise, though on an annualised basis this should fall short of the Fed’s 2% target. On balance, a rate hike as early as June is not a done deal.
The FOMC minutes also record disagreement as to whether the data would be sufficient for such a move. While concerns about a prolonged slump in growth seem to have disappeared, inflation pressure in particular could still be too low for many FOMC members. The Brexit referendum a week after the FOMC meeting and its potential for market turbulence is also a risk factor. We therefore adhere to our forecast that the Fed will not yet raise rates in June. But the risk has grown that it will act in June or shortly thereafter.
