The Fed’s dual mandate of price stability and maximizing sustainable employment seem to be on track. Labor markets continued to tighten as the Fed achieved its inflation target of 2% last week.
While the Fed has already embarked on its path to tightening monetary policy, the pace at which it will tighten remains in question. The committee was split at their March meeting on whether they should hike three or four times this year. As of this writing, the recent economic data seems to have fueled the futures market’s expectation of an increased probability of four hikes.
The May jobs report will keenly be analyzed given its release, about two weeks before the Fed’s next meeting on June 13th and 14th, when another 25 bps rate hike is widely expected. After June, the Fed is scheduled to have four more meetings in 2018.
So now, it’s not whether the Fed will raise rates but the pace at which the Fed may tighten. Uncertainties continue to linger around the impact of fiscal policy changes, the budget recently passed in Washington and trade policies. For example, higher tariffs could serve as a boon to inflation just as fiscal policies could fuel growth and price pressures. The U.S. ended two-days of trade talks with China on Friday, with no deal nor a scheduled time to speak again.
Increased productivity and business spending as a result of the tax cuts will also be closely monitored. For now, the market practitioners seem to be gearing up for an economic expansion and interest rate levels, not seen in over a decade.
Unemployment Falls to 3.9%, a 17-year Low
Nearly 164k jobs were created in April, resulting in the unemployment rate dropping from 4.1% to 3.9%. Underemployment fell to 7.8%, its lowest level since 2001. The positive news does come with some thorns, wage growth continues to remain flat for the third month in a row and signs of a shrinking labor force were evident as well.
Note, the Fed is expecting a 3.6% unemployment rate next year.
Inflation Hits Fed’s 2% TargetThe personal consumption expenditure index, a key data point the Fed looks to as an inflation gauge, increased to 2%, compared to 1.7% in February. Further core inflation reached 1.9% in March, compared to 1.6% in February. It appears inflation is finally catching up to the economic growth story in the U.S., giving the Fed more reason to hike rates in the coming months.
Separately, on Friday, Fed Official, John Williams, who will soon assume the role as head of the NY Fed in June noted that inflation could overshoot the bank’s 2% target.
FOMC Keeps Key Rate Unchanged, Gradual Increases Expected
As largely expected, the FOMC unanimously kept the Fed Funds rate unchanged within the 1.5% to 1.75% range last week, with the market anticipating the next hike at the June meeting. As inflation starts to firm, strong labor markets and higher wages all fuel a tightening monetary policy. Note, unemployment data was released after the Fed met last week.
Looking ahead this week:
The Chicago Mercantile Exchange is expected to launch futures based on the Secured Overnight Financing Rate or SOFR this week. The launch of SOFR based futures is meant to be the first step towards a term structure for the rate, similar to LIBOR.
Key U.S. data includes: Consumer credit change (Monday), PPI data (Wednesday), April CPI data (Thursday), April monthly budget statement, export/import price index (Friday) and Michigan consumer sentiment.
Fed officials scheduled to speak include: Rob Kaplan (Monday), Charles Evans, Raphael Bostic (Wednesday) and James Bullard (Friday).
Overseas data includes: Swiss CPI (Monday), JPY overall household spending, CNY trade data (Tuesday), German trade data, CAD housing starts, AUD consumer confidence (Wednesday), JPY leading economic index, NZD monetary policy decision, GBP retail sales, JPY foreign investments, CNY PPI/CPI data (Thursday), GBP manufacturing production, GBP trade balance, EUR economic bulletin report, BOE rate decision, GBP quarterly inflation report, JPY machinery orders, NZD business NZ PMI, AUD investment lending for homes (Friday) and CAD unemployment.
