Must-know: Fed’s July minutes reveal higher rates are near

Market Realist

Key investor takeaways from the Fed's July FOMC minutes (Part 6 of 9)

(Continued from Part 5)

July FOMC minutes reveal higher rates are near

Before the Fed begins monetary policy normalization, it would need to close in on its twin targets—inflation and employment. Inflation and employment have implications for consumption. Consumption is the most important economic growth driver.

The operating environment for firms—for example, companies in the S&P 500 Index (SPY), the NASDAQ-100 (QQQ), and the Dow Jones Industrial Average (DIA)—influence employment. Businesses tend to hire when the economy is growing. Since 2008, the Fed has tried to stimulate investments and employment by keeping rates low.

However, now the economy is reviving. The Federal Open Market Committee (or FOMC) minutes revealed discussions on recent labor market and inflation improvements. Both indicators showed improvements that were better than the Fed expected. At this rate, the Fed could reach its inflation and employment targets earlier. As a result, FOMC participants believed that monetary accommodation could be removed earlier than they initially thought. This would imply a rate hike that was earlier-than-expected.

Recent trends in the labor market

The labor market was showing unexpected strength. The unemployment rate fell more-than-expected in June. It came in at 6.1%. Job openings and hiring were also increasing. Labor force participation had remained steady, while long-term unemployment fell. However, household income wasn’t showing signs of increasing.

The Fed’s take on higher inflation

The Fed had been concerned about inflation for months before the July FOMC. Inflation consistently fell short of the Fed’s target. The Fed indicated that rate tightening wouldn’t start until inflation was near 2% levels.

Recently, the change in personal consumption expenditure (or PCE)—the Fed’s favored inflation measure—was increasing. The PCE increased from 1.1% in March to 1.6% and 1.8% in April and May, respectively.

The Fed acknowledges higher inflation

The impact of these changes were reflected in the FOMC’s July statement. It said “The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2% has diminished somewhat.”

Higher inflation implies higher nominal interest rates. Bond prices (BND) fall when interest rates increase. However, inverse exchange-traded funds (or ETFs), like the ProShares UltraShort 20+ Year Treasury (TBT), would benefit if rates increase.

Outlook

Market participants watch the Fed’s economic and financial market update. The market update reveals the direction the economy is headed. We’ll discuss this in more detail in the next two parts.

Continue to Part 7

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