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By HaleStewart May 22, 2016 7:45 am
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US Bond Market Week in Review: The Fed Takes A Hawkish Tone

     On Wednesday, the Fed released the minutes from their latest meeting.  The commentary was generally upbeat.  Participants viewed the labor market favorably, citing low unemployment, improving labor force participation and several anecdotal sources for support.  And while overall PCE inflation was 1%, the core rate was approaching their 2% target.  This combination led to this key conclusion:

Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee's 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June. 

But the committee’s economic analysis and projections were not universally bullish.  The strong dollar, weak oil prices and soft international environment led to a second consecutive quarter of contracting business investment.  Moreover, some participants viewed risks to growth and inflation as tilted toward the downside.  Others expressed concern about potential international fallout associated with the UK’s upcoming “Brexit” vote or China’s handling of monetary policy.  Still, the narrow parameters of the Fed's dual mandate (maximum employment and price stability) granted the Fed sufficient latitude to argue for a June rate hike.     

     SF President Williams gave an upbeat speech earlier this week.  He argued poor seasonality adjustments again caused a weak first quarter GDP reading.  His staff used a second set of seasonal adjustments and arrived at a 2% 1Q growth rate.  The 5% unemployment rate, positive JOLTS survey quits level, and recently rising labor force participation rate support his positive labor market assessment.  And using the recent 1.6% core PCE inflation rate and the 1.8% trimmed mean CPI as support, he argued inflation was moving closer to the Fed’s 2% target. 

      Williams’ discussed his analysis at the same conference where Atlanta Fed President Lockhart expressed a similar outlook:

Atlanta Fed chief Dennis Lockhart and San Francisco’s John Williams both signaled on Tuesday that the U.S. economy could warrant a rate hike when the policy-setting Federal Open Market Committee gathers on June 14-15. Investors currently only see a 12 percent chance of such a move, according to pricing in interest rate futures contracts.

“I would put more probability on it being a real option,” Lockhart told reporters at the Atlanta Fed’s financial markets conference at Amelia Island, Florida, when asked about the low implied odds of a move next month. “The communication of committee participants and members between now and mid-June obviously should try to prepare the markets for at least a realistic range of possibilities” for the next policy meeting.   

Lockhart also cited a strong labor market and rising inflation in a May 3rd speech, which explains why both governors are in the hawkish camp.

     Finally, earlier his week, James Picerno at the Capital Spectator offered a very insightful analysis of the 30-2 yield curve spread.  After noting that the recent 2 and 30 year yield history paint a “less-threatening profile,” he presents the following two graphs:

Both show various longer EMAs; the top chart is for the 2-year treasury while the bottom chart is for the 30.  The 30-year chart shows a clear long-term downward trend that, should it continue, will eventually move below the 2-year’s EMA’s.  Longer EMAs are less susceptible to short-term noise, giving them slightly more predictive power.  While the trend is certainly not set in stone, it bears watching.


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