Key Points:
- Fed likely to be monitoring the PCE Deflator results closely.
- June rate hike still possible but caution is likely.
- Failure to tighten monetary policy likely to lead to a greenback depreciation.
The past few weeks have probably left many readers questioning just how strong the case for a June rate hike from the U.S. Federal Reserve is. To date, we have seen some significant tightening in labour market conditions, as well as renewed forecasts of economic growth from the Atlanta Fed. However, you would be forgiven for questioning these data points given that the last release of FOMC minutes seemed to take a dovish tone and hint at the need for additional economic strength to be seen. Subsequently, a June rate hike appears to be anything but a done deal and here’s why:
Inflationary Pressures
Central banks typically love manageable inflation and the Fed is no different in this regard. However, despite tremendous amounts of QE having been injected into the U.S. economy, and falling unemployment nearing natural levels, we are yet to see much in the way of sustained inflation being reported. In fact, the Fed primarily looks at the Personal Consumption Expenditure (PCE) readings, which coincidentally are due out today, as a gauge to give them a lens to measure inflationary pressures, primarily demand pull, in the domestic economy. However, the latest reading of the PCE showed a worrying downtick that largely matched the relatively lacklustre Q1 GDP results. Subsequently, the central bank will be looking for a relatively strong result before they will consider near term rate hikes.
Wage Inflation
In extension to the PCE, wage inflation is also another measurement that can be applied to provide us some insight into pent-up demand within the economy. Unfortunately, hourly earnings have been relatively flat over the past year which shouldn’t be surprising given the rise in part time employment. The reality is that without well paying, full time jobs, people are typically loathe to spend what money they possess on consumable items.
1st Quarter GDP Growth
The central bank was a little shell shocked when the Q1 GDP was revised downwards and immediately reached into the bucket of excuses to explain why. Chief among them was the suggestion that this was just a transitory weakness and that they expected the following quarter to drive additional growth to match the Atlanta Fed’s GDPNow forecasts. However, this has largely turned into farce with the forecast seemingly changing weekly. Subsequently, some members on the FOMC are now clearly expressing concern that the downward GDP revisions could, in fact, form a trend.
Slowdown in China
China was always going to experience a slowdown at some stage given the successive years of a rapidly growing economy. Unfortunately for the Federal Reserve, the slowdown appears to coincide exactly with the bank thinking of normalising their interest rates and winding back their balance sheet. Subsequently, the FOMC is right to be concerned as to the impact on trade and demand as the juggernaut that is/was the Chinese economy starts to slow down.
Ultimately, I suspect that the FOMC’s decision is likely to hinge upon the PCE Deflator results due out later today. An abject lack of inflationary pressures in the indicator could very well cause the Fed to remain cautious and hold off on a rate rise to their next FOMC meeting. However, that will surely lead to the USD falling further and the bubble that is the S&P growing ever more present.