Fed Eager To Raise Interest Rates In June, But Is It Serious This Time?

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Fed Eager To Raise Interest Rates In June, But Is It Serious This Time?

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert

May 24, 2016

IN THIS ISSUE:

1. Raise Interest Rates? Fed Policy Meeting Minutes Warn of June Rate Hike

2. Raise Interest Rates? Fed Officials Get Very Vocal About a June Rate Hike

3. Raise Interest Rates? Fed Rate Hike Fears Have Stock Markets on the Defensive

4. Raise Interest Rates? What You Need to Know About the So-Called “BREXIT”

Raise Interest Rates – Overview

On Wednesday of last week, the Fed released the minutes from the most recent policy committee meeting on April 26-27. The official policy statement at the conclusion of the meeting suggested that the Fed was in no hurry to raise the Fed Funds rate anytime soon. Yet the actual minutes made public last week tell a very different story.

In fact, a majority of the policy committee members agreed in late April that the next rate hike should happen at the upcoming June 14-15 meeting, unless there is some unexpected negative surprise in the economy. This same majority believed that the US economy was strong enough to warrant a June hike in the Fed Funds rate and maybe more later this year.

Even before the meeting minutes were released last Wednesday, several top Fed officials went on the record saying not only that rates should rise at the June policy meeting, but there could well be another rate hike or two this year beyond that. As you might expect, this news hit equity markets very hard last week. Here we go again! Details to follow below.

Following that discussion, I will offer some thoughts about the upcoming vote on June 23 to decide whether Great Britain will remain a member of the European Union or will abandon it. If the UK decides to withdraw from the EU – the so-called “BREXIT” – it could roil equity and bond markets around the world.

Between the Fed decision on June 15 and the UK decision on June 23, we could see some wild market gyrations in the weeks ahead, and the outcome could potentially be very ugly.

Raise Interest Rates? Fed Policy Meeting Minutes Warn of June Rate Hike

The latest meeting of the Fed policy-making committee was on April 26-27. The official policy statement released following that meeting was quite bland and included no warning that an interest rate hike was on the front burner. That was good news for stocks.

Yet on Wednesday of last week, the Fed released the actual minutes from that April 26-27 policy meeting, which painted a very different picture of what the Fed Open Market Committee (FOMC) focused on at the April meeting.

In essence, a majority of FOMC members agreed at the April meeting that another Fed Funds rate hike should occur at the next policy meeting on June 14-15, unless there are negative surprises in the US economy or elsewhere.

According to the minutes released last week, a rate increase in June is contingent on three developments:“economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the [Fed’s] 2% objective.”

Let’s break those down. First, there is growing evidence that the US economy is recovering in the 2Q. Most forecasters now expect that US GDP will have recovered from only 0.5% in the anemic 1Q to 2.0-2.5% in the 2Q.

Second, labor market conditions have continued to improve this year. The official unemployment rate is down to 5% for the second consecutive month, the lowest rate since the Great Recession, and what most economists consider at or near “full employment.”

Third, US inflation is making progress toward the Fed’s target of 2%. Most of us gauge inflation by looking at the Consumer Price Index (CPI). The CPI rose more than expected in April by 0.4%. For the 12 months ended April, the CPI rose by only 1.1%. However, “core” CPI (less food and energy) rose 2.1% year-over-year. The Fed is certainly aware of this and it may be why Fed officials became so vocal about a rate hike in June (more on this below).

Generally, the Fed watches a different inflation indicator known as the Personal Consumption Expenditures Index (PCE). It is a different measure of inflation put out by the Commerce Department. The Fed focuses on the “core” PCE which excludes food and energy, not the broader PCE Index.

The latest core PCE report showed a decline in April after rising modestly since late last year. Yet even with the slight downtick in April, the Index stood at 1.56% year-over-year, which is not that far from the Fed’s 2% target and the overall trend remains higher.

Raise Interest Rates Personal Consumption
Raise Interest Rates

Raise Interest Rates? Fed Officials Get Very Vocal About a June Rate Hike

The members of the Federal Reserve’s monetary policy-making committee have been anxious to hike rates for most of the past year. You may recall that they wanted to begin hiking back in September, but were put off when market volatility threatened to undermine the American economic recovery.

In December they managed to get the first Fed Funds rate increase on the books, and Committee members were feeling confident as 2016 began. Stanley Fischer, the Fed Vice-Chairman, suggested that 2016 would be a “four-hike year.” Instead, markets spent the first two months of the year in a near panic, and here we are in mid-May with just the one December rate hike behind us.

Over the last month or so, it is clear that the Fed is feeling good about the state of the economy, and is ready to give higher rates another chance. Over the last few weeks, just about every Fed official to wander within range of a microphone warned that more rate hikes might be coming sooner than many people anticipate.

This impression was confirmed by the FOMC minutes from the April 26-27 policy meeting that were released last week, which included: “Most participants judged that if incoming data were consistent with economic growth picking up…then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June.” 

Most of the time Fed officials are hesitant to make public statements about monetary policy, much less what they think should be done with interest rates. Last week, however, at least four top Fed officials made some very specific comments which all suggested that the policy committee is ready to make its next move at the upcoming FOMC meeting on June 14-15.

No less than four top officials made comments on Tuesday of last week, including San Francisco Fed President John Williams, who said that “two or three rates hikes” this year was a reasonable assumption, contrary to Wall Street’s expectation of only one rate increase in 2016.

Richmond Fed President Jeffrey Lacker told The Washington Post that the case for a June rate hike was“pretty strong.” Dallas Fed President Robert Kaplan said the US economy was strong enough to justify a rate hike in the “not too distant future.” And New York Fed President William Dudley said that a rate hike in June or July is a “reasonable expectation.”

What’s curious in all of this is why these Fed officials are suddenly feeling so confident about the economy. Recall that the last policy meeting was on April 26-27. The very next day on April 28 the Commerce Department reported that 1Q GDP was weaker than expected at 0.5%.

Given that this information on the weak economy was not known during the April FOMC meeting, and the GDP number on April 28 was weaker than expected, it might stand to reason why the Committee included language suggesting a rate hike at the June meeting. But the very next day, the Fed got the 1Q GDP report which confirmed that the economy was weaker than expected in the 1Q.

The question is, what information has the Fed seen since April 28 to make the Fed officials quoted above so confident about the economy as to suggest another rate hike in June? The Index of Leading Economic Indicators last Thursday showed a better than expected gain of 0.6% in April. The housing sector had modest gains last month as well. Retail sales for April came in slightly better than expected.

As suggested above, it could well be that last Tuesday’s Consumer Price Index report, showing the “core” Index up 2.1% in the last 12 months, was the catalyst for the latest calls for a rate hike in June.

Fed Chair Janet Yellen is scheduled to speak at Harvard University later this week. It will be interesting to see if she cites rising inflation as the main reason for the new push to hike in June and maybe even another increase later this year.

In conclusion, several top Fed officials are clamoring over a Fed Funds rate hike at the June 14-15 FOMC meeting. And the equity markets are NOT happy about it. What else is new?

Raise Interest Rates? Fed Rate Hike Fears Have Stock Markets on the Defensive

It’s been nearly a year since the S&P 500 hit its all-time high. The Dow Jones Industrial Average has been flirting with the 18,000 level for over a year. Yet for the past three months, the Dow has been stuck in a 500-point trading range. But as you can see below, the S&P 500 has been trending lower since early April.

Raise Interest Rates S&P 500 Index
Raise Interest Rates

US equities have consistently reacted negatively to Fed rate hikes, and this time should be no different. The chart above looks quite bearish, what with lower highs on the last two rallies and lower lows in the January/February selloff.

While the Fed is says the US economy is improving, the equity markets are sending a very different message: disappointing US economic growth, weak consumer spending in the 1Q, falling global trade volumes, energy sector defaults, credit woes in China, falling corporate profitability, etc.

And let us not forget that in less than a month on June 23 the British electorate will vote on whether or not Britain will leave the European Union. Most forecasters believe that if the so-called “BREXIT” occurs next month, it will be very negative for England’s economy, and therefore its stock markets. Increased volatility in all major global equity markets is likely to surge if the Brits vote to exit the EU (more on this below).

On top of all that we add the new possibility that the Fed will raise rates 2-3 times this year when the markets were expecting only one increase. So as we enter a period of historical seasonal weakness for stocks, investors would do well to brace for a turbulent summer.

Futures traders increased the odds of a June interest rate hike from 4% to 35% by the end of last week. I expect it to go much higher if Fed officials continue flapping their lips.

Raise Interest Rates – What You Need to Know About the So-Called “BREXIT”

A national referendum will be held on Thursday, June 23 to decide whether Britain should leave or remain in the European Union. A referendum is basically a vote in which everyone (or nearly everyone) of voting age in the United Kingdom can take part with a “Yes” or “No” answer to the question. Whichever side gets more than half of all votes cast will be the winner.

Those allowed to vote include British, Irish and Commonwealth citizens over 18 who are residents in the UK, along with UK nationals living abroad who have been on the electoral register in the UK in the past 15 years. Citizens from EU countries living in the UK generally will not get a vote.

The referendum question is: “Should the United Kingdom remain a member of the European Union or leave the European Union? Pretty black-and-white, wouldn’t you say? The British people are fairly evenly split according to recent opinion polls, so the vote could go either way. Prime Minister David Cameron wants Britain to stay in the EU but under different terms.

Those who want to leave the EU generally feel that Britain is being held back by the many rules imposed on businesses by the EU and by the excessive membership fees. They also want Britain to take back full control of its borders and reduce the number of people coming there to work.

If the Brits vote to leave the EU, it will be a monumental decision for both sides, which could roil markets around the world. There is a link below to an article from BBC News that discusses the pros and cons of the BREXIT.

Raise Interest Rates?? Late Note: There is increasing speculation that the Fed will wait for the results of the BREXIT referendum before raising the Fed Funds rate a second time, opting instead to raise the rate at the July 26-27 policy meeting. I’m not so sure.

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