Fra BNP Paribas:
he Federal Reserve has clearly signalled that the economy is very close to where it needs to be in terms of employment and that payrolls are now well in excess of the ‘par’ rate. The key questions are whether recent data threaten a continuation of this trend and where the balance of risks lies.
With consumption, consumer confidence and jobs all solid, the occasional cloud, such as the ISMs, does not blot out the blue sky. Since its last meeting, the Fed is likely feeling more, not less, confident in its baseline scenario. At the same time, foreign risks look as benign as they have for over a year. It is difficult to argue that above-par payrolls do not counter weak ISMs in weighing risks to the Fed’s scenario.
The risks facing the economic outlook are more balanced now than at any time since the FOMC lifted off from the zero lower bound in December 2015. Moreover, relative to both the last FOMC meeting (July 26-27) and the last FOMC meeting with a Summary of Economic Projections (June 14-15), the US economy looks better, on balance.
The labour market is markedly stronger, household spending remains firm after accelerating in Q2, financial and monetary conditions are easier, and there are nascent signs that business investment will bounce back in H2 2016. However, not all indicators are pointing north, with recent disappointments on both ISM (manufacturing and non-manufacturing) surveys standing out as well as inflation measures that remain stubbornly low.
We think the continued improvement in the labour market and more benign risk environment will support the case for a rate hike in September. This would not the first rate hike of this tightening cycle, but rather the second that has been delayed by global events and bad strings of data. In our view, the Fed is not in a rush to hike.
At the same time, it does not want to wait until every economic and financial duck is in a row before raising rates again – doing this may prove to be a never-ending game that locks the Fed out. The data is are not perfect, but they are solid and supportive of a hike. To date, FOMC members have struck a rather hawkish chord with markets that do not believe the Fed will deliver a hike if everything isn’t lined up.
With the current market odds of a September hike in the sub-25% neighbourhood at the time of writing, the Fed has limited time to get a market-moving FOMC member like NY Fed President William Dudley on the mic and in tune with the Fed’s intentions. While this is not a necessary condition for a hike, we see it as the easiest way to get markets more on board.
