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Summer Rate Hike Probability Rising As Markets Eye May Jobs Report

Friday’s May jobs report will provide some clues about whether a summer rate hike can be expected. Some economists believe that Mr. Market will be greatly surprised if policymakers do raise rates over the summer, while others believe investors are finally coming around to the idea. At any rate, there’s still a great deal of uncertainty about when the Federal Reserve will raise interest rates again and how many times it will do so this year.

Looking to May jobs report for more information

The Fed has made it clear that employment data is one of the key economic indicators it will use when determining when to hike interest rates. On average, economists expect the Labor Department’s May jobs report to show that 160,000 non-farm payrolls were added during the month. April’s number was slightly weaker than expected at about 160,000 jobs added.

Capital Economics believes Mr. Market continues to underestimate the pace at which the Fed will hike interest rates. The firm is also well behind the consensus in terms of its estimate for the May jobs report. The firm believes only 120,000 jobs were added in May and notes that the Verizon strike will greatly weigh on the number, negatively impacting telecommunications payrolls.

Also due on Friday are the International trade report and the ISM Non-Manufacturing Index report. Capital Economics expects the trade numbers from April to indicate that experts are “on track for a big second-quarter rebound.” The firm is concerned that the ISM Manufacturing Index might drop, but it believes that another modest improvement in the Non-Manufacturing Index will more than offset that decline.

Mr. Market unsure of timing of next rate hike

Capital Economics reports that markets are clearly unsure about when the Fed will hike interest rates again, which it states is “understandable given the Fed’s woeful communications over the past 12 months.” The firm believes that the decision about whether to raise rates next month will depend entirely on what the May jobs report says. After the report, the markets will then be watching Fed Chairperson Janet Yellen’s speech, which is set for Monday just ahead of the one week of required silence before the FOMC’s next meeting on June 14 and 15.

The Fed has been delivering mixed messages about what it will do. More recently, Fed members’ comments have been very hawkish, but any sign of trouble in the May jobs report could quickly change their tune.

Interest rate hikes may come faster than expected

While some economists are taking the Fed’s recent hawkishness with a grain of salt, Capital Economics appears to be taking it seriously. Although the firm believes policymakers will only raise rates two more times this year, it also believes that they will become more aggressive with their tightening next year. They expect the Fed Funds target range to rise to between 2.25% and 2.5% by the end of next year.

Source: Capital Economics
Source: Capital Economics

As far as summer rate hikes are concerned, Capital Economics states that investors mostly believe the Fed will raise rates soon (which conflicts with what other firms have stated), June Fed Funds Futures have risen by just 0.02%. Meanwhile August futures have climbed 0.11%. Because the Fed’s June meeting falls mid-month, they expect the effective rate to remain 0.37% in the first half of the month.  Looking at 0.41%, Capital Economics estimates that the markets are pricing in a 30% chance of rates being hiked 25 basis points to 0.63% at the June meeting.

may jobs report Source: Capital Economics
Source: Capital Economics

The firm adds that calculating probability for July is more difficult because the FOMC meeting is at the end of the month, which is why they skipped July and looked at August.