Mixed economic data will impede the Fed

Don’t expect the Fed to raise rates at its next meeting.

In a speech this afternoon, U.S. Fed member Lael Brainard gave several reasons for the central bank to hold off on further hikes in the short-term. These include the feeble performance of the U.S. economy and its labour market, and the Brexit vote.

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Overall, markets have become extremely sensitive and continue to expect “a prolonged period of low growth, low inflation and economic underperformance,” he says. This is evident when you look at factors such as the current negative term premium for 10-year Treasury notes, or the difference between the yield on the 10-year Treasury and expected risk-free short rates over the next 10 years.

“Prior to the Great Recession, the term premium was positive [because] bond investors seem[ed] to have been most concerned about the risk that inflation would be higher than expected,” Brainard explains. “But since [then], the term premium has been persistently negative, suggesting investors have instead been focused on the risk of prolonged lower-than-expected inflation in the context of low growth and underperformance.”

Read: Meet the kids challenging the Fed

The U.S. economy has improved since mid-February, but Brainard attributes this shift to more gradual tightening of U.S. monetary policy. “Should an event trigger renewed fears about global growth or a reassessment of the policy reaction function in the United States, turbulence could return,” he warns.

In a release, CIBC Capital Markets economist Avery Shenfeld says, “[You] can’t dismiss the weakness in American jobs creation […] We admit to being worried, but at this point, we’ll stick with our view that U.S. Q2 growth will show a healthy rebound, putting the Fed in position to hike rates in September.”

Read: U.S. Fed shouldn’t be data-dependent: Tal

If you look at CME Group’s FedWatch tool, which is based on 30-day Fed Fund futures prices, there’s less than a 5% chance that rates will rise this month—the split between dissenters and optimists was closer to 70%-30% prior to the release of today’s jobs numbers, with markets still largely expecting the Fed to hold. For September, there’s around a 40% chance that rates will be hiked by 25 basis points and about a 7% chance that they’ll rise by 50 basis points.

Staff

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