We believe the Fed is close to ticking all the boxes it needs for lift-off. Slack in the labour market has been reduced substantially and is not far from being fully used up. Wage inflation is starting to pick up on certain measures and indicators of wage pressure, such as job openings and the quit rate, point to a continued rise in wage growth. Core inflation has moved higher lately, giving the Fed more confidence it will reach the 2% inflation target in the medium term. Overall uncertainty is not at an unusually high level, although there are risk factors such as Greece and emerging market growth.
However, there is one more box the Fed wants to tick before it starts its lift-off mission. It wants confirmation that the weakness in Q1 was indeed due to temporary factors and that growth has bounced back to the 2.5% cruising speed as it expects. We believe we will see this in the coming months and that it will pave the way for lift-off in September. This is now very much the consensus view among analysts but the market is still pricing the first hike in December.
We are already seeing tentative signs that the economy is rebounding: initial jobless claims have pushed lower over the past one to two months and the Conference Board’s leading indicator showed the strongest increase in April since July last year (see Strategy: Euro area growth takes a breather while US rebounds, 22 May). We expect growth to increase to around 2.5% in both Q2 and Q3 and believe we will see more signs of this materialising in upcoming data releases. Next week offers important information, with the release of ISM manufacturing for May on Monday, where we are looking for a slight increase from 51.5 to 51.7. The job report on Friday will also be in focus, although the Fed does not put too much weight on a single report. However, it wants to see a continued steady improvement of the labour market with job growth around 200,000 per month. We expect a rise of 220,000 (in line with consensus of 223,000).
To Read the Entire Report Please Click on the pdf File Below