- Markets dial back rate-hike expectations after FOMC meeting
- Unemployment claims remain in good shape
- U.S. core CPI expected to edge higher
- NAHB index expected to edge higher
- U.S. current account deficit expected little changed
Markets dial back rate-hike expectations after FOMC meeting — The FOMC yesterday at the conclusion of its 2-day meeting softened its Fed dot projections for future rate hikes and reduced its GDP forecasts for 2016 to +2.0% from +2.2% and for 2017 to +2.0% from +2.1%. In addition, Ms. Yellen in her press conference perhaps admitted more than she intended when she said that “we’re quite uncertain about where rates are headed in the longer term.” She also said that the Fed is prepared to adjust its views “to keep the economy on track,” which seemed to be a thinly veiled assurance that the Fed is open to reverting to new stimulus measures if the U.S. economy starts heading for a recession.
Ms. Yellen admitted that next Thursday’s Brexit vote was a factor in the FOMC’s decision to leave rates unchanged. She said that Brexit “is a decision that could have consequences for economic and financial conditions in global financial markets” and that the vote “could have consequences in turn for the U.S. economic outlook.”
The Fed was clearly shaken by the recent May payroll report of +38,000 (+73,000 ex-Verizon). That weak payroll report might simply reflect a temporary hiring slowdown after the weak Q1 GDP growth rate of +0.8%. However, weaker payroll growth could also snowball into a slowdown in consumer income, confidence, and spending, ultimately resulting in a recession since consumer spending is the only leg holding up the U.S. economy. There was at least some encouraging news on Tuesday when May retail sales rose +0.5%, stronger than expectations of +0.3% and building on April ‘s surge of +1.3%.
As a result of yesterday’s FOMC meeting, the federal funds futures curve fell by 3-4 bp for late 2016 and by 4-5 bp for 2017. The FOMC results caused the odds for a rate hike at the next FOMC meeting on July 26-27 to drop to only 4% from 14% the previous day and from the much-higher 62% before the May payroll report was released. The federal funds futures market is assessing the odds for a rate hike by year-end at only 42%. If the Fed does not raise rates at its next meeting on July 26-27, then it may have a hard time raising rates at its following two meetings (Sep 20-21 and Nov 1-2) since those dates get dangerously close to the Nov 8 presidential and Congressional elections, potentially interfering with the outcome of those elections.
Unemployment claims remain in good shape — The market is expecting today’s initial unemployment claims report to show an increase of +6,000 to 270,000, more than reversing last week’s -4,000 decline to 264,000. Meanwhile, the market is expecting today’s continuing claims report to show an increase of +45,000 to 2.140 million, reversing about one-half of last week’s -77,000 decline to 2.095 million.
Both the initial and continuing unemployment claims series remain in good shape, indicating that layoffs remain at very low levels historically even as job hiring slowed in the last several months. The initial claims series is only +16,000 above the 42-2/3 year low of 248,000 posted in March 2016 while the continuing claims last week fell to a new 15-3/4 year low.
U.S. core CPI expected to edge higher — The market is expecting today’s May CPI to be unchanged from April at +1.1% and the May core CPI to edge slightly higher to +2.2% from April’s +2.1%. The core CPI is slightly above the Fed’s inflation target of +2.0%, but the Fed’s preferred inflation target is not the CPI but rather the PCE deflator. The PCE deflator was at only +1.1% y/y in April and the core PCE deflator was at +1.6% y/y, comfortably below the Fed’s +2.0 inflation target. The core PCE deflator has been moving sideways in the range of +1.6-1.7% for the last four months, indicating a lack of upward inflation pressure.
Market expectations for inflation have tailed off in the past two weeks. The 10-year breakeven inflation expectations rate on Tuesday fell to a 3-month low of 1.48% before rising slightly to 1.50% yesterday. The Fed is currently under no pressure to raise interest rates from an inflation perspective.
NAHB index expected to edge higher — The markets are expecting today’s June NAHB housing market index to show a +1 point increase to 59 from the 58 level seen in the previous four months (Feb-May). The NAHB index is only 7 points below the 10-year high of 65 posted in Oct 2015, indicating that U.S. home builder confidence remains strong despite the various challenges facing the U.S. economy. U.S. housing starts in April rose by +6.6% to 1.172 million units, which was only -3.4% below the 8-1/2 year high of 1.213 million units posted in June 2015.
U.S. current account deficit expected little changed — The market is expecting today’s Q1 current account deficit to narrow slightly to -$125.0 billion from -$125.31 billion in Q4. The current account deficit is seeing widening pressure from weak exports but is seeing offsetting narrowing pressure from the lower value of U.S. oil imports due to historically low oil prices.
The persistently wide U.S. current account deficit is an underlying long-term bearish factor for the dollar since a net $1.4 billion worth of trade dollars are flowing out of the U.S. every calendar day. Those dollars end up being sold into the forex markets to the extent that the recipients of those trade dollars do not retain those dollars and invest them in dollar-denominated investments.
