Twas clearly much more than a quip
When several Fed speakers did flip
The narrative’s tune
‘Bout rate hikes in June
Implying that this time they’ll skip
However, don’t think that they’re done
As they know that in the long run
Inflation’s not dead
And Jay Powell’s said
They’ll not stop til this battle’s won
We learned some important new things yesterday regarding the economy and the Fed’s current reaction function, namely that the Labor market continues to be pretty hot and, more importantly, that despite that fact, the Fed is almost certainly going to forego a rate hike this month. Regarding the Labor market, yesterday’s JOLTs Job Openings data printed back above 10 million openings after a dip below that level in the previous two months indicated that there was less labor demand. This is crucial because the Fed clearly watches this number closely as part of their employment situation dashboard, and more openings implies more wage pressure higher, the key thing Powell and friends are trying to ameliorate. After the release, stocks, which had opened lower already, fell a further 0.5% as expectations for a 25bp rate hike in two weeks rose further.
But never fear, when it comes to supporting financial markets, the Fed is always there to help and yesterday was no different than normal. While, as noted yesterday, non-voter and uber-hawk Loretta Mester was clear she saw no reason to pause, we subsequently heard from two other Fed speakers, Philadelphia’s Patrick Harker and Governor (and vice-chairman select) Phillip Jefferson, that now would be a good time to pause skip a meeting and look around at how the already 500 basis points of rates hikes are impacting the economy.
“I am in the camp increasingly coming into this meeting thinking that we really should skip, not pause, but skip an increase. A pause would mean the Fed is going to hold its policy interest rate steady for a while. It is too soon to make that call,” explained Harker at the OMFIF* Economic and Monetary Policy Institute. [emphasis added]
Meanwhile, Philip Jefferson explained, “a decision to hold our policy rate constant at a coming meeting should not be interpreted to mean that we have reached the peak rate for this cycle. Indeed, skipping a rate hike at a coming meeting would allow the Committee to see more data before making decisions about the extent of additional policy firming.” [emphasis added]
Rounding out the guidance was an article from the Fed Whisperer, the WSJ’s Nick Timiraos, highlighting these two speeches and clearing any doubt that a rate hike on June 14th is a dead issue. So, summing things up, the Fed is going to hold fire in two weeks but fully well expects to tighten policy further starting in July unless something really significant occurs. It should be no surprise that the Fed funds futures market has adjusted its pricing to a 30% probability of a hike in June (down from ~65% yesterday morning) and an additional 45% probability of one by July. I am confident, that barring a remarkably strong NFP number on Friday, that we will see that June probability shrink even further, likely to around 20%.
How will this impact markets? Well, yesterday saw the first equity weakness in a while, although US markets only fell about -0.6% on the day. However, we are already seeing a rebound as Asian markets were broadly higher, albeit not dramatically so, and we are seeing real strength in Europe this morning with the DAX higher by more than 1.1% and leading the way. The interesting thing about Europe is that early this morning we saw the PMI Manufacturing data releases and it was not a pretty picture. Germany (43.2) was the laggard, but the Eurozone as a whole (44.8) was hardly something to write home about. In fact, these PMI readings have been sub-50 since last July, a pretty strong indication of a recession. Adding to the dysfunction was German April Retail Sales, falling -8.6% Y/Y, back to Covid levels, and before that, last seen in 1980! Arguably, this ongoing weakness in economic data is going to stay Madame Lagarde’s hand when it comes to the ECB’s policy tightening. The combination of lower headline CPI data and clearly weaker economic activity will make any more rate hikes, especially in the face of a Fed that is not hiking this month, much more difficult.
As to bond yields, this morning they have stabilized after their recent sharp declines. Right now, we are looking at slightly higher yields, on the order of 1bp to 2bps, which seems to be merely a trading reaction to the previous week’s decline of 18bps. With the House having passed the debt ceiling bill last night (it now moves to the Senate), that market drama seems to have ended so I expect we will get back to talking about the economy and the Fed again, as well as, of course, inflation.
Oil prices (-0.4%) are continuing their downward slide as regardless of any supply questions, this market sees demand as cratering as we head into a recession. It is, of course, this price action, that has the deflationistas back crowing again about the inevitable collapse of CPI and how the Fed will need to reverse course quickly. I am not in that camp, but only time will tell. Meanwhile, gold (+0.25%) and copper (+2.3%) are telling a different story, especially copper. It is hard to make sense of a rising copper price, the metal most closely associated with economic activity, and a simultaneous decline in oil. But hey, nobody ever said markets made sense. This will resolve itself at some point, but clearly not today.
Finally, the dollar is a non-event today, with about half the G10 and EMG blocs rising and the other half sliding, none more than about 0.3%. Movement like this is hard to define as anything more than position adjustments and trading activity with no real catalysts seen.
On the data front, we get a bunch of releases today as follows:
- ADP Employment 170K
- Nonfarm Productivity -2.4%
- Unit Labor Costs 0%
- Initial Claims 235K
- Continuing Claims 1800K
- ISM Manufacturing 0
- ISM Prices Paid 3
The ADP number is a day late due to the Memorial Day holiday on Monday, but I cannot help but look at the productivity and ULC data and consider how negative that is for the economy writ large. As well, we hear again from Patrick Harker, the last scheduled speaker before the FOMC meeting on the 14th. Of course, we heard his views yesterday so I doubt there will be anything new.
A skip is not a pause, and I believe that the Fed will not be deterred from their mission at this stage. This means that the market will continue to price in tighter Fed policy and the dollar is likely to benefit accordingly.
*OMFIF is the Official Monetary and Financial Institutions Forum, a think tank devoted to banking and central banking. I, too, have never heard of this before.