The minutes from the April FOMC (Federal Open Market Committee) meeting left little doubt that market participants had been misreading the Fed’s inclination to hike rates this year. Before the Fed minutes were released, the market had placed only a 28% chance of a hike by July and only a 46% chance of a hike by September. But market participants had misjudged the Fed’s intention; the minutes of the April meeting told us so:
“Most [FOMC] 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.”
This is unusually specific language for the Fed – to single out the next meeting as “appropriate” for a hike. The last time such language was used, in the statement following the October 2015 Fed meeting, the Fed followed through with a hike at the December meeting. Also note how the Fed has not set a particularly high hurdle, above: Second quarter economic data will likely be stronger than the depressed first quarter data (although the GDP numbers themselves will not be released until July, after the June meeting, the Fed will be looking for signs that second quarter data is tracking GDP growth at an annualized rate at or above 2%). The labor market data for May, which is released on 3 June, will be crucial to the Fed decision at its 14–15 June meeting as it will help the Fed determine whether labor market conditions are continuing to strengthen after the somewhat softer-than-expected April report. The April Fed minutes also convey these somewhat unusual confessions:
“Some [FOMC] participants were concerned that market participants may not have properly assessed the likelihood of an increase in the target range at the June meeting, and they emphasized the importance of communicating clearly over the intermeeting period how the Committee intends to respond to economic and financial developments.” “It was noted that communications could help the public understand how the Committee might respond to incoming data and developments over the upcoming intermeeting period. Some members expressed concern that the likelihood implied by market pricing that the Committee would increase the target range for the federal funds rate at the June meeting might be unduly low.”
So will the Fed hike in June? After the release of these minutes, the market-assigned probability of a June hike jumped from 12% to 32% and odds of a hike by July jumped from 28% to 47%. So, message received. In the coming days and weeks, Fed officials will have a chance – through interviews and speeches – to clarify their thinking. For example, earlier today, New York Fed President William Dudley noted that June would be a “live” meeting depending on how the data evolves. My sense is that many Fed officials expect the data to support two hikes this year, with some participants in favor of three hikes if the data hold up as they expect, as suggested by this passage in the April minutes:
“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.”
More so than market participants thought (at least before yesterday), the Fed perceives a cost in not hiking if delay confuses the public on its reaction function. April’s minutes, and Fed communication in the coming weeks, are an effort to align market expectations with the Fed’s intentions.