The Fed Stuck in Dovish Holding Pattern

By Brian Dolan, Head Market Strategist Fed Steady in June

The minutes from the April 28-29 FOMC meeting (Federal Open Market Committee) have all but squashed any chance that the Fed will hike at its June 17 meeting. While not explicitly ruling out a rate increase, “many Fed officials saw a June rate rise as unlikely,” according to the minutes. Market expectations were already close to zero for a June lift-off (the first rate hike from the current 0-0.25% Fed Funds Target rate), so the market reaction was relatively muted: stocks reversed earlier declines and bond yields and the US dollar dipped slightly.

Among other key highlights from the minutes:

  • Most Fed officials still saw risks to the outlook as nearly balanced;
  • FOMC discussed but rejected the idea of an explicit signal on the timing of lift-off;
  • A number of Fed officials saw reasons 1Q weakness may persist, but most expect moderate growth to resume;
  • Some Fed officials were concerned by the outlook for consumer spending;
  • Fed officials saw US dollar strength exerting a drag on growth ‘for a time;’
  • FOMC members highlighted the risks of volatility after lift-off.

All in all, another dovish Fed outlook. Market consensus expectations are now centered on the September 17 meeting as the most likely time for the first rate increase since the end of 2008.

Outlook Increasingly Data Dependent

The Fed has previously indicated it will need to see data sufficiently strong enough to justify a rate increase. In particular, the Fed has pointed to continued improvement in the labor market, and a ‘reasonable’ expectation that inflation will move toward its 2% goal. In light of recent weakness in US reports and ongoing global headwinds, we don’t expect economic data over the summer to be sufficient to trigger a September rate lift-off.  We continue to focus on a Dec. rate move at the earliest, and preferably no action until 2016.

Either way, the outlook for the Fed and markets in general will be increasingly data dependent in the coming months. Given typically lower liquidity during the summer months, we think market volatility may increase substantially. This will likely amplify the impact of incoming data reports, better or worse, and make for potentially treacherous intra-day price movements.

Market Views

Overall, we expect stocks to remain a buying opportunity on weakness unless economic data takes a material turn for the worse. Bond yields have effectively priced in a ¼% rate hike over the last month, but, there especially, constrained liquidity may see heightened volatility. The more solid the data appears, the higher rates can go; 2.40% in US 10 year Treasury yields looks like a break-point for rates to move higher. Our expectation, however, is that data is more likely to disappoint and that yields may drop back to 1.90-2.0% area.

The US dollar should resume strengthening, again unless the data weakens sharply, as the European Central Bank accelerates its bond buying program ahead of mid-July. US dollar strength may trigger a fresh wave of commodity and oil price declines. The CRB commodity index and US crude oil (WTI) appear to have already broken lower, suggesting the rebound since mid-March has run its course.