Home > XE Currency Blog > US Bond Market Week in Review: The Fed Returns to a Rate Hike Stance


XE Currency Blog

Topics7265 Posts7310
By HaleStewart July 31, 2016 7:27 am
  • XE Contributor
HaleStewart's picture
HaleStewart Posts: 792
US Bond Market Week in Review: The Fed Returns to a Rate Hike Stance

     To better understand this week’s Fed announcement, it’s important to compare the economic backdrop between the June 14-15 and July 26-27 meeting.  While first quarter GDP growth was ultimately revised higher, the final 1Q report was still a weak 1.4%.  Industrial production was still contracting on account of oil sector weakness and to a lesser extent, the strong dollar.  May’s weak employment report, showing a paltry 11,000 net gain in establishment jobs, sent shockwaves through the financial markets and the Fed; the report lowered the 12, 6 and 3 month average job growth figures to 204,000, 172,000 and 147,000, respectively.  The combination of these factors provided the Fed with enough justification for taking a wait and see attitude regarding rate hikes in June. 

     A great deal has changed since in the ensuing 6 weeks.  Industrial production has increased in 2 of the last 3 months and the latest employment report showed very strong job gains.  The leading and coincident indicators printed their best and second best results in 7 months.  Perhaps most importantly, the markets have so far survived Brexit; the equity markets sold off in response to the vote, but have since rebounded, making new highs.  The primary negative development is the continued shrinking of the yield spread.  But just as May’s weak employment report was insufficient to force the Fed to reverse course, so too are declining bond yields insufficient to prevent a more aggressive stance.

     In its latest statement, the Fed argued the economy was increasing moderately, with rising employment and strong household gains.  However, business investment and inflation expectations remained weak.  These observations have been remarkably consistent over the last 6-9 months.      

     The Fed again stated they would take a gradual approach to raising interest rates:

The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

The above language is very similar to that in previous releases.  And, as usual, the Fed is taking a “data dependent” approach, which is hardly surprising.

     That leaves the question about how the latest GDP report plays into the Fed's analysis.  At this point, I would think they're taking a wait and see approach.  Friday's release was the first of three GDP reports, leaving the possibility of a higher number in the revisions.  And the internal numbers weren't as negative as the headline number would lead a reader to believe; consumers are still spending at strong rates while business investment is contracting.  And domestic demand is moderately strong while employment growth returned to a robust pace in the latest report.  I seriously doubt the Fed will alter their thinking unless additional data bearish data emerges.



Paste link in email or IM