Following the jobs report last week, there is no doubt that the Federal Reserve committee dialed it back significantly from its recent “rate hike rhetoric.” It was only a month ago that the Fed Governors were boldly claiming a rate hike was coming sooner rather than later. This past Friday, they presented a mixed picture of the economy; there are some growth areas but there is weakness in others.
From their recent statement:
Information received since the Federal Open Market Committee met in April indicates that the pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up. Although the unemployment rate has declined, job gains have diminished. Growth in household spending has strengthened. Since the beginning of the year, the housing sector has continued to improve and the drag from net exports appears to have lessened, but business fixed investment has been soft. Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation declined; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.
Fed Governors were miffed that the market was not pricing in a potential hike in June or even July. A bit of lip service took the Fed Funds Futures expectation from 7% probability for a June hike to 38% probability. Sometimes the market listens to such warnings, and indeed equity markets did pull back in mid-May. However, the drop was short-lived. The bulls seized control, taking the SPX 500 near all time highs once again. It seemed the stock market “agreed” with the Fed that a rate hike was going to be okay – yet the bond market thought otherwise.
The markets rarely if ever get it wrong, and that is so often true about the bond market. We have not seen an appreciable rise in yields in a long while, hence the economic outlook by the bond market has been spot on – weakening until further notice. Make no mistake – that jobs report is a major red flag that may portend trouble on the horizon. This caught the Fed off-guard for sure. An economy growing at 2% a year does not have much slack to work with before heading into a recession. Is the Fed happy about 2% growth? Of course not, especially when the potential is greater. But without aggressive fiscal policy, it’s what they have to work with.
The very weak jobs report lit a fire under the Fed Funds Futures. The odds for a short term rate hike diminished considerably, and market volatility started to rise once again from the ashes. How confident the Fed seemed to be about raising interest rates was thrown into doubt yet again. The Fed statement showed they would take cover behind weak data and the uncertainty over the Brexit vote.
Yet, the jobs report was a shot across the bow, and the Fed knows it. Last week, St. Louis Fed President James Bullard stated he expects no more than ONE rate hike into 2018. Kansas City Fed President Esther George, often a dissenter on the voting panel, decided to make policy unanimous. This is a notable shift. Perhaps she sees things are becoming a bit worse than they had been. One jobs report does not make a trend, and with a weak June report on July 8, they could dial it down even more – but it’s getting tight and with very little wiggle room left.
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