FOMC Minutes

Does it make a case for a Fed rate hike in June?

The recent FOMC minutes released during the week was interpreted by markets as a signal of front-ending of rate hikes by the Fed. There was virtual unanimity in holding Fed rates in the 0.25%-0.50% band, with just one dissenting vote at the FOMC meet. But a closer analysis of the minutes of the meeting surely throws up the possibility of another rate hike this year.

Employment and inflation… 

The US has moved as close to full employment as possible. With unemployment at around 4.9%, the scope for further reduction in unemployment is hard to come by. The unemployment level is already below the 5% cut-off set by the Fed. Inflation is another parameter to watch out for. Of course, inflation is way below the mandated 2% mark. However, rising consumer demand and rising demand for housing indicates that the liquidity in the system is finally driving inflation. Weak inflation is largely a function of cheap oil and commodities. With oil getting closer to $50/bbl and most industrial commodities rallying over the last 3 months, the US may be actually much closer to 2% inflation than we can imagine at this point of time.

Data versus expectations…

While the Fed has traditionally focused on data-based decision making, there seems to be a subtle shift in this FOMC meet. The Fed has decided to focus more on expected data flows rather than on actual flows. This could be very important while analyzing the inflation data on a regular basis. While the inflation is way below 2%, the FOMC strongly expects the inflation number to move towards 2% once the impact of cheap oil gets eliminated. This may induce the Fed to hike rates even if inflation is below 2% if the Fed expects inflation to follow a path towards 2% in the foreseeable future. This is a key structural shift in the Fed approach to rate setting that needs to be noted.

Front-ending versus Back-ending…

The big question is whether the rate hikes will be back-ended or front-ended. A rate hike in the June FOMC meet looks highly unlikely. There is the BREXIT vote on June 25 and the Fed will prefer to wait and watch due to its larger implications for the OECD. China, EU and Japan are still struggling to grow and the US would not be too keen to upset the applecart. Also, US exports have been falling and that can be largely attributed to the strength of the dollar. A rate hike would only make the dollar stronger.

But the shift to data expectations is a subtle hint of a rate hike. Most likely, a rate hike could happen either in September or November. With the risk of monetary divergence, the rate hike will be gradual and measured! ©

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