US: Markets likely to shift their focus to the FOMC meeting - Rabobank

After digesting the UK election results, and industrial production and trade balance data from a number of European countries that are released today, the markets are likely to shift their focus to the FOMC meeting that will take place next Tuesday and Wednesday, suggests Philip Marey, Senior US Strategist at Rabobank

Key Quotes

“Since FOMC speakers did not push back against market expectations of a June rate hike before the start of the Committee’s black-out period, it would take an extreme adverse event to avert a hike next Wednesday. While employment growth is not exuberant, it is sufficient to absorb the inflow to the labor market. Moreover, the near standstill in March (only 50K) seems to have been temporary, followed by average growth of 156K in April and May. Finally, unemployment fell to 4.3%, well below the FOMC’s estimate of the longer run unemployment rate of 4.7%. This means that the labor market data are likely to be sufficient for the Fed to hike for the second time this year.”

“What’s more, other data suggest that the economy is doing well in Q2 with the Atlanta Fed’s nowcast at 3.4% (as of June 2) after the modest – albeit plagued by residual seasonality – Q1 GDP growth rate of 1.2%. Note that the minutes of the previous meeting in May indicated that members generally judged that it would be prudent to await additional evidence indicating that the recent slowdown in the pace of economic activity had been transitory before taking another step in removing accommodation.”

“However, the combination of unemployment at 4.3% (well below the Fed’s 4.7% estimate of the NAIRU) and average hourly earnings growth of only 2.5% year-on-year (well below the Fed’s preferred 3-4%) suggests that the FOMC will have to make another downward adjustment to its estimate of the NAIRU. Note that the Committee did the same at the previous round of projections in March when the estimate was reduced downward to 4.7% from 4.8% in December. More importantly, it suggests that inflation pressures remain in the distance.”

“The FOMC may also make a downward revision to its PCE inflation projections which in March suggested 1.9% for both the headline and core measure in the final quarter of this year. Note that in April the PCE deflator fell to 1.7% while the core measure fell to 1.5%. Back in February headline inflation was 2.1% and core inflation 1.8%. This shows that we are currently moving away from the Fed’s 2.0% target for PCE inflation, which could delay the Fed’s intended third hike of this year until 2018.”