- June 14-15 FOMC meeting minutes expected to confirm dovish shift even before Brexit
- ISM non-manufacturing index expected to recover modestly from May’s 2-1/3 year low
- U.S. trade deficit expected to moderately expand
- Weekly EIA report
June 14-15 FOMC meeting minutes expected to confirm dovish shift even before Brexit — Today’s minutes from the June 14-15 FOMC meeting will provide some insight into the Fed’s thinking about a week before the June 23 Brexit vote turned the Fed’s thinking even more dovish. The FOMC at the conclusion of the June 14-15 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%.
Ms. Yellen in her June 15 post-meeting 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. The FOMC was clearly shaken by the recent downtrend in U.S. payroll growth, which culminated with the very weak May payroll report of +38,000 (+73,000 ex-Verizon strike).
The FOMC was already concerned about the U.S. economy before the surprise Brexit vote. The Brexit vote then produced an even larger dovish shift in market expectations for Fed policy. The Brexit vote caused the federal futures curve to plunge by 11 bp for the Dec 2016 futures contract, by 13-21 bp for the 2017 contracts, and by 23-27 bp for the 2018 contracts. The federal funds futures market is currently discounting the chances of a Fed rate hike at zero for the next two FOMC meetings on July 26-27 and Sep 20-21. The market is discounting the chances at only 12% for a rate hike by the end of this year. The market is not discounting a 100% chance of the Fed’s next rate hike until September 2018, which is more than two years away.
Looking ahead, the outlook for Fed policy now depends heavily on the incoming U.S. economic data and particularly this Friday’s June payroll report. The market consensus is for Friday’s payroll report to show an increase of +175,000. If Friday’s payroll report instead shows another very weak report of below about +75,000, then the market’s current dovish view of Fed policy will be confirmed and there will be increased talk that the U.S. economy may be headed for a recession. By contrast, if U.S. payroll growth can rebound to the +175,000 area over the next few months, then the markets will likely shift to a much more hawkish view of Fed policy, particularly because of the muted global market response thus far to Brexit. Indeed, FOMC hawks are already starting to gear back up post-Brexit as San Francisco Fed President John Williams yesterday said that the Brexit vote, “as it’s played out so far” is only “a relatively modest risk to the U.S. outlook.” He said that a 2016 Fed rate hike is warranted if his projections are met for a drop to the unemployment rate to 4.5% this year and a rise in inflation.
ISM non-manufacturing index expected to recover modestly from May’s 2-1/3 year low — The market is expecting today’s June U.S. ISM non-manufacturing index to show a small +0.4 point increase to 53.3, recovering a bit after May’s sharp -2.8 point decline to 52.9. The ISM non-manufacturing index was as high as 55.8 in Dec 2015, but the index then slid to a 2-1/3 year low of 52.9 by May, reflecting the poor GDP growth rates seen in the last two quarters as well as slowing employment growth. Markit has already reported that its preliminary-June U.S. services PMI was unchanged at 51.3, which did not bode well for today’s ISM report. On the more positive side, last Friday’s June ISM manufacturing index was unexpectedly strong and rose by +1.9 points to 53.2, which at least indicated that manufacturing confidence improved in June.
U.S. trade deficit expected to moderately expand — The market is expecting today’s May U.S. trade deficit to expand moderately to -$40.0 billion from -$37.4 billion in April. The U.S. trade deficit in March (-$35.5 billion) and April (-$37.4 billion) was favorably narrow compared with the 12-month moving average of -$41.0 billion. There was also some good news in the April trade report as April exports rose by +1.5% m/m to a 4-month high of $82.8 billion. The April level of exports is still down sharply by -8.7% from the record high of $200.2 billion posted in Oct 2014, but exports at least posted a rise in April. In general, U.S. exports remain weak because of poor overseas demand and the generally strong dollar.
Weekly EIA report — The market consensus for Thursday’s weekly EIA report, which will be delayed by a day due to Monday’s holiday, is for a -2.5 million bbl decline in U.S. crude oil inventories, a -600,000 bbl decline in Cushing crude oil inventories, a -200,000 bbl decline in gasoline inventories, a +200,000 increase in distillate inventories, and a +0.5 point increase in the refinery utilization rate to 93.5%.
U.S. crude oil inventories have fallen for the last six consecutive weeks by a total of -2.7% due to strong oil demand from refineries that are operating at full tilt to produce summer gasoline. However, U.S. oil inventories have only been showing the normal seasonal decline and remain in a massive glut at +33.3% above the 5-year seasonal average. Meanwhile, U.S. product inventories are more than ample. U.S. gasoline inventories are +11.5% above the 5-year seasonal average and distillate inventories are +17.7% above average.
On the production front, U.S. oil production continues to fall despite the partial recovery in oil prices over the past several months. U.S. oil production last week fell by -0.6% to a new 1-3/4 year low of 8.622 million bpd, which is down by an overall -988,000 bpd (-10.3%) from the 44-year high of 9.610 million bpd posted in June 2015.