Wednesday, July 13, 2016

Fed Continues to Signal Patience on Interest Rates

Two of the Federal Reserve presidents that sit on the Federal Open Markets Committee (FOMC) had appearances scheduled this morning.  These one-off speeches are followed by traders, however it's important to bear in mind that they represent the views of the individual voting (or non-voting, in some cases) member and do not represent the FOMC as a whole.  What's more important is following any change in tone respective to the individual.

Dallas Fed President Robert Kaplan confirmed what was reported a couple of days ago related to growth, and said he expects the GDP to continue in the 2% range for the year.  He expressed the view that this growth rate is very slow, and considers boosting growth to be the most important economic issue we are currently facing.  Without going into details, he said that doing so would require some structural changes that are outside of the mandate afforded the Federal Reserve.  That would appear to be a not-so-veiled nudge to Congress related to trade and growth stimuli.

Providing a brief glimpse into the thinking of FOMC as a whole, Kaplan also stated that the Federal Reserve is "very sensitive" to the strength of the US Dollar.  Indeed, this one statement is the best signal we have that interest rates will remain low for the foreseeable future since any rise in rates would further strengthen the dollar to the detriment of US exports and to the earnings of US companies with heavy overseas exposure.  Until the entire Brexit issue is resolved and we start to understand the new dynamic in Europe, it's unlikely that the US dollar will weaken.

Meanwhile, Minneapolis Fed President Neel Kashkari spoke at a Town Hall meeting in Marquette, Michigan.  He directly addressed interest rates, saying, "We feel like we can be patient to let the economy continue to heal before we start moving aggressively to raise rates. We should take our time when we go ahead and start raising rates again. There's not a huge urgency to raise rates because inflation is coming up low."

His wording suggests that he's expressing the views of FOMC, not just his own, and it's consistent with what we've been hearing from the other Fed Presidents over the last couple of weeks.  It's interesting to note Kashkari's focus on inflation, compared to Kaplan's focus on the strength of the dollar.  By definition, a monetary "Hawk" is primarily interested in maintaining inflation at the Fed's mandated 2% target.  A "Dove" by contrast, is focused primarily on unemployment (and other non-inflationary factors) with an interest in maintaining unemployment under 5%.

Kashkari is a newcomer to FOMC, replacing the extremely dovish Narayana Kocherlakota in November, 2015. It's important to note that Minneapolis (and thus, Kashkari) will not be a FOMC voting member until 2017.  Still, hearing Kashkari take a hawkish position focused on inflation gives us some insight into where he will fall in the economic spectrum next year.  (The categorizations of hawks favoring interest rate hikes and doves favoring holding rates low are not accurate categorizations of the terms.)

While Kashkari is currently siding with the doves regarding keeping interest rates low, he also stated that he sees moderate growth ahead.  Whether that's above the 2% cited by Kaplan is unknown, but few would consider that level to be "moderate growth."  He made it a point of saying that he does not foresee a recession and does not believe the Fed will have to ease monetary policy.  (Following the dismal job numbers from May and a decline in the GDP in that period, there was some discussion of lowering interest rates or even introducing a new round of Qualitative Easing, although the June numbers have pushed those thoughts to the background again.  Kashkari clearly rejects the notion of either.)

FOMC holds their next meeting the 26th and 27th of July, with their next announcement scheduled for 2:00 PM on the 27th.  The futures market shows a 0% chance of an interest rate hike in either July or August, and only a 12% chance of a rate hike in either September, October, or November.  The odds of a rate hike jump to 30% in December, however that's more of an indication that anything can happen over the next five months.  We now have some analysts projecting the next rate hike as late as June, 2017.

For short-term traders, it does mean that we will not have artificial volatility over the next couple of months based on interest rate speculation.  It also means that dividend players will have very limited exposure going into 2017.  (Remember, higher interest rates put selling pressure on lower-yield stocks.)  We'll be interested in the FOMC release more as a gauge of what pressures the Fed sees over the next quarter both here and abroad, however at least in the July meeting we don't anticipate any signal that interest rate talk will heat up any time soon.

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