The Federal Reserve removed the word “patient” from their forward guidance at the most recent meeting and Fed Head Yellen spoke in very “dovish” terms when asked about the timing of the first rate hike. The rewording of the forward guidance was expected, however Mrs. Yellen’s dovish tone took the markets by surprise and allowed rates to move lower.
The volatility seen recently is here to stay until the Fed makes clear when the first rate hike will occur and at what velocity the market can expect the Fed Funds rate to rise. It is important to remember the Fed only controls the shortest-term rates, basically overnight loans.
When will the first hike occur? Mrs. Yellen has been clear from the beginning of her term as head of the Federal Reserve that all monetary policy decisions will be based on economic data and the rate of inflation. The Fed has a dual mandate from congress, full employment and price stability. Full employment (the rate at which everyone who wants a job has one) is a moving target, however most economists believe an unemployment rate of 5% represents a healthy labor market. Price stability as defined by the Fed is an inflation rate of 2%.
With the exception of the jobs report, most economic data points to a slowdown in the US economy. This data includes industrial production, retail sales and housing starts. The downbeat shift in data complicates matters for the Fed. The last thing the governing body wants to do is raise rates only to have the economy contract and force their hands to add accommodations.
Inflation is running well below the 2% target rate the Fed has set. Since commodities are priced in US dollars, the strong dollar has pushed food and energy costs lower, which also applies pressures to the core rate.
The single most important release the Fed is watching and one that will cause them to raise rates quickly is the wage component of the monthly jobs report. Any hint of inflation in wages will cause the Fed to act quickly, even in the face of other data that may be weaker than expected. The US consumer has not seen wages rise above inflation since the late 90’s and are long overdue for a “raise”. Rising wages can be very good for the US economy because 67% of our economy comes from consumer spending, however it can also kick off a cycle of inflation. A sure sign that the labor market is tightening was Target’s announcement over the weekend that they are raising the minimum wage in all stores. Stay tuned.
What to expect in the future: More volatility. Economic data is the #1 reason mortgage rates move and there are three events we need to be especially cautious of. The monthly jobs report released on the first Friday (April 3rd) of each month has the ability to either jump start Fed rate hike fears or can suppress those sentiments. The Fed meets every six weeks with the next meeting scheduled for April 28th-29th. The minutes from the last meeting will be released April 8th and will give global investors an indication of what was discussed at the March meeting.