Key Points:
- Federal Reserve FOMC split on the need for rate hikes.
- Uncertain pathway for rate hikes over the next quarter.
- 1-Year Treasury Yield Curve showing rising nominal rate expectations.
Wednesday saw the latest round of minutes from July’s FOMC meeting released which largely showed most members split down the middle on near term rate hikes.
Despite initial reports that a rate hike was looming as early as September, the reality appears to be that most FOMC members are going to need some significant improvement in the US economic indicators before agreeing to further monetary tightening.
Clearly, there is a relatively strong divergence of views amongst the various committee members that is only likely to get wider whilst there is an abject lack of price inflation within the US economy. Typically, the Fed has sought to get ahead of inflationary pressures and has tallied their policy largely within the gains made in the labour market.
However, the broader US data shows that the labour market is in relatively strong shape especially when you consider that unemployment is below 5% and rapidly approaching the natural rate.
Regardless, concerted inflation is currently largely absent and we are not seeing either sharp gains in real wages or indeed robust retail sales figures.
In fact, consumer prices in the US have largely been declining throughout most of 2016 after some strong gains in January. So there appears to be little in way of data to support increased inflation over the next few months.
Subsequently, it is clear that gains in the labour market alone are not enough to move the remainder of the FOMC towards additional rate hikes and that we are fairly unlikely to see the inflationary pressures that most members are seeking, at least within the next quarter.
Therefore, the message from the Fed on the potential forward risks of rate hikes has been largely mixed and it has complicated the markets' ability to form their expectations.
In fact, a cursory review of the daily treasury yield curve rates tells us that the 1-year rate has pushed out to 0.58% as of yesterday. The key thing to realise about yield curves is that they include both the current nominal interest rate as well as the forward expected rate. Subsequently, the yield curve is telling us that there is a market expectation of rate hikes within the near term.
Figure - Daily Treasury Yield Curve
However, much of the increase in expectations has been fuelled by some of the more outspokenly hawkish members of the FOMC. Subsequently, the yield curve may not be the best predictor of future rate hike chances given the central bank's strong misuse of the expectations channel.
At this point of time, the Fed is boxed into a corner with a diminished global growth outlook and an abject lack of strong, consistent inflation. Regardless of how strong the labour market might be (largely due to part time employment) unless those gains flow through to consumption we are unlikely to see the sort of the data that the Fed needs to hike rates.
Subsequently, I highly doubt that we are going to see a rate hike from the central bank in September and would suggest that we may be likely to repeat the pattern of 2015’s “Will They, or Won’t They” debate for the remainder of the year.