Get ready for a September rate hike; that seems to be the takeaway from Capital Economics’ 20 July Fed Watch research note.
The report, penned by Capital Economics’ analyst Paul Ashworth, presents a view that runs contrary to the consensus, although the observation is based on improving economic data, a pickup in activity and employment both of which show that the US’s economic recovery has regained momentum.
October fed funds futures imply an 18% chance of a rate hike in September, a view that is based on the world’s deteriorating economic situation and concern about the state of the US’s economic recovery.
However, Capital Economics point out if you just concentrate on the economic data regarding the US economy, it’s difficult to argue against a September rate hike. To quote Paul Ashworth, if the US economy continues unabated on its current course, “it is hard to see how the Fed could justify not raising rates in September”.
The Fed should hike interest rates in September
Paul Ashworth bases his case on a number of key data points. For example, consumption has been exceptionally robust this year. The three-month-on-three-month annualised growth rate of control group retail sales hit a two-year high of 7.4% during June. Meanwhile, second quarter real consumption growth was around 4.5% annualised and overall GDP growth was around 2.5% for the same period. Ashworth notes that this rate of expansion is somewhat unsustainable, and consumption growth is likely to drop back to a more sustainable pace during the second half of the year. Nonetheless, the economy should benefit as the drag is from net external demand and the year-on-year contraction in mining -related investment dissipate. The research outfit believes US GDP growth should average between 2% and 2.5% during the second half of 2016.
We will find out next week if the apparent pickup in second-quarter GDP growth has actually materialised and there should be further information on whether the rebound in employment growth in June has continued. After the release of these data points, second-half predictions should be more believable.
Paul Ashworth believes that if you look through all the noise, the US economy is in robust shape. Employment hasn’t fallen off a cliff, it has just slowed as expected. The average monthly payroll gain in the first half of this year slowed to 172,000, from 237,000 in the second half of last year but gains of 200,000 plus per month were never going to be sustainable. Meanwhile, financial conditions of eased considerably, in trade -weighted terms the dollar remains well below the earlier peak and has been broadly unchanged for the past 12 months. And:
“For those Fed officials who are sceptical of any link between labour market slack and inflation (Lael Brainard and James Bullard being the most vocal), inflation expectations play a particularly important role. The June FOMC meeting took place shortly after the news that households’ medium-term inflation expectations had fallen precipitously. That decline was subsequently revised away, however, and the latest data suggest that household inflation expectations have actually rebounded recently.”
So overall, the data seems to point to a rate hike later this year, although we’ve seen over the past couple of years, the Fed is becoming increasingly data- immune in its policy decisions. Capital Economics’ Paul Edwards ends his research note with this damning statement:
“All things considered, if the Fed really was data dependent, then a rate hike in September would seem to be warranted… But nothing is straight-forward with the Yellen-led Fed.”