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How Is June 2016 Actually Looking for a Rate Hike?

David Ashworth

How the April FOMC Minutes May Have Just Turned up the Heat

(Continued from Prior Part)

The Fed looks ready

More often than not, the Federal Reserve’s meeting minutes have a limited impact on financial markets. The case of the April 2016 was different, however, because policymakers sounded notably hawkish in the meeting minutes. Most of them were satisfied with economic progress, and had it not been for inflation and global developments, a rate hike could have happened in April itself.

A few policymakers were concerned that that positive reading of the economy unaccompanied by a rate hike was sending conflicting signals. The April 2016 minutes noted that “A couple of participants were concerned that further postponement of action to raise the federal funds rate might confuse the public about the economic considerations that influence the Committee’s policy decisions and potentially erode the Committee’s credibility.”

The Fed also risks runaway inflation, in addition to the loss of credibility. Surging inflation warrants an aggressive policy stance, which means a sharp rise in interest rates. A sharp rise in interest rates can be hurtful to long-maturity bonds (TLT) (PRULX), and will force investors into shorter duration bonds and instruments (BSV) (SCPB) as well as inflation-protected bonds (FINPX).

Market expectations

A week before the release of the April 2016 minutes, the CME Group FedWatch showed that the probability of a June rate hike was 4%. As of May 20, that probability rose to 26.3%. This shows that though market participants are not completely pricing in a rate hike in June, chances are much higher than just one week previously.

Since the April meeting itself, job additions for April and PCE inflation for March have been released. Both have declined. While the decline in inflation was expected, the news from the jobs front came as a surprise. Participants will now watch for the second estimate of economic output, PCE inflation for April, and the nonfarm payrolls report for May to gauge whether the Fed will find itself in a position to effect a rate hike in June.

Of course, we’ll keep an eye on those developments on our Global ETFs and Mutual Funds pages.

Browse this series on Market Realist: