(New York) Investors listened attentively as Federal Reserve Vice Chairman Stanley Fischer spoke at an economics conference in New York. Attendees were eager to hear his comments after awaking to finance news channels along with the front pages of all the leading financial newspapers declaring June as a strong possibility for the Federal Reserve Bank to enact it’s second rate hike.
Dr. Fischer was careful not to comment on whether the Fed would raise rates in June and kept the bulk of his comments on the subject matter. However, he did make one foreboding statement in regards to the current economy and the Fed’s mandate. “What we need most, now that we are near full employment and approaching our target inflation rate, is faster potential growth,” said Vice Chairman Fischer.
The Fed wanted to execute two more rate hikes this year. The notion of a rate increases is being championed by Dr. Fischer behind the scenes. Additional comments by the New York Federal Reserve President William Dudley were eerily similar as he stated, “We are on track to satisfy a lot of the conditions” for a rate hike. It isn’t a coincidence that both men echoed the same sentiment.
However, a June rate increase is highly unlikely because that would mean two consecutive rate hikes in both June and July–since this is an election year the Fed will not want to interfere with the election cycle–that leaves fall hikes off the table.
From an economic perspective the yield curve should flatten, and the front end of the yield curve isn’t what affects the economy. The back end of the yield curve affects mortgages and corporate financing–consequently corporate bond sales are surging in this environment. This issuance allows firms to cushion soft sales as investors search for yield. This has been driven by the low rate environment, sensing the impending hikes and inflation corporations are maximizing issuance opportunities.
All Fed meetings are live-which means that the Fed can affect rate decisions sans a news conference. The July meeting doesn’t have a press conference, so market participant expectations are focused on the aspect of coverage along with a review of the last meetings discussions–increasing the anticipation is that they will affect a rate in June. This is the hot money and they have the wrong impression for the following reasons:
a) The Fed still operates on a data dependent basis and the current conditions are not remotely supportive in the U.S.
b) The feedback loop as the dollar strengthens effectively does the work of a rate increase
Given the consideration of the Gross Domestic Product (GDP) and real inflation–the possibility of either of those indicators turning to enable a rate increase decision between now and the June meeting is very low.
The excitement was driven by Fed minutes which revealed that June was targeted. The voracity of the hawkish comments surprised investors who considered the Fed completely dovish. Despite the frequency of rate increase comments in the last meeting– July is still the most likely time to effect a rate hike.
President Jeffrey M. Lacker of the Federal Reserve Bank of Richmond spoke on Bloomberg television about the data being high enough to get a rate hike in. Lacker made it a point to state that the pause was underestimated, he had pushed for a rate hike in April. He further stated that global risks had dissipated leaving a hike clearly within mandate. As a last point, Mr. Lacker also cited that the issue of a “Brexit” being sigificantly reduced. This is a cogent factor because the Fed meets before the referendum vote and will want to be able to respond accordingly.
These statements are telling because they show how international noise continues to cloud the issue in the minds of the central bankers. The weak economic performance in Europe and Asia is also of particular note, due to knock on effects that will be brought on by a rate increase here. Last, the question of inflation will be on the minds of all central bankers. Statement by ECB officials seem to intone that inflation is over its mandate– Governor of the Reserve Bank of India, Raghuram Rajan hinted as much in his speech at the University of Chicago, London Booth campus,
Something that bears consideration, is that the Fed seems to be on a concerted effort to transmit the message that they aren’t as dovish as the market perceived. The concerted effort by the FRB to communicate through multiple people within a twenty four (24) period cannot be ignored. Stay tuned for a final word from the Chairwoman Yellen herself, she will speak at Harvard on May 27th.
More than likely, this signaling effort was driven by the fact that the Street had a near zero percent chance of a rate hike–something Chair Yellen doesn’t want. So the hawkish comments in combination with the release of the last meetings minutes can be a direct effort to eliminate that. Expect a definitive market response.
As a final note, China does loom large in the calculations even if officals are reticent to admit it. China is still pegged to the dollar and as the highest GDP in the world, rate increases will have a direct effect on its economy which is negative for the global economy.
Net effect: one and done until 2017.