The US Federal Reserve looks set to pursue its monetary tightening agenda, but dollar bulls have taken a step back following some slight dovish undertones in the minutes of the central bank's last meeting.
At the 3 May meeting, the Fed agreed to keep the Fed funds rate at 0.75%-1%, having raised it by a quarter of a percentage point at its March meeting.
While markets appear to have priced in a further rate increase at the June meeting, the Fed minutes introduced a sliver of doubt about Fed policy beyond June.
June rate rise still likely
The Fed had eyed three quarter-point moves for this year, having signalled at the 15 March meeting that it expected two further increases in 2017.
Since the March meeting, however, the US economy has been seen to have hit a patch of sluggish activity and some doubt has been raised about the schedule of further rate hikes.
"Although expectations of a rate hike in June were realised when Federal Reserve officials said it would 'soon be appropriate' to raise rates again, the longer-term hiking path remains clouded," says Lukman Otunuga at FXTM.
‘Transitory’ soft patch
While the labour market has continued to add jobs and reduce unemployment and inflation runs close to the Fed's target rate, gross domestic product growth of 0.7% in the first quarter was disappointing.
The central bank notes in the minutes: "Although the incoming data showed that aggregate spending in the first quarter had been weaker than participants had expected, they viewed the slowing as likely to be transitory."
But the Fed's monetary policy committee members introduced enough doubt into this forecast that markets have started to take note.
The following note of caution has put the dollar under pressure and seen Treasury yields dip.
The minutes continue: "Members generally judged that it would be prudent to await additional evidence indicating that the recent slowing in the pace of economic activity had been transitory before taking another step in removing accommodation."
Growth slows into Q2
Let's take a look at some of the recent data that may be casting doubt in the minds of the committee.
- As already noted, US growth expanded at an annual rate of 0.7% in the first quarter, down from 2.1% in Q4 2016, due to slowing consumer spending
- Manufacturing growth is slowing: April's ISM business activity index for the sector dropped to 54.8 from 57.2 in March; Markit's measure of the sector fell to 52.5 from 52.8. In both indexes, a reading above 50 indicates expansion
- New home sales for April fell 11.4% after rising 5.8% in March, while existing home sales were down 2.3% after a 4.2% rise in March
- Fed gauges of manufacturing activity are falling: Empire state index fell to -1 from +5.2 in April; Philadelphia Fed index fell to 25.8 in May from 34.9 in April; Richmond Fed index fell to 1 in May from 20 in April
The data all point to the likelihood that the economy's soft patch of the first quarter has started to extend into Q2. Few are in doubt that a June rate hike remains on the table, but beyond this is anyone's guess.
Otunuga adds: "With Fed policymakers more than likely to hold off hiking interest rates further until there is solid evidence that the recent economic deceleration is transitory, hard economic data from the US will come under heavy scrutiny moving forward."
The data ahead
So let's examine some of the data releases to come in the next few days, and what the Fed is likely to make of them:
- Tuesday, 30 May: Personal consumption expenditure in April the Fed's favoured measure of inflation as it incorporates consumer spending. Markets expect PCE to remain at 1.8% as in March
- On the same day are the related personal spending and income, and any fall in these measures is likely to concern the Fed that consumer confidence is waning
- Also on Tuesday is the Dallas Fed manufacturing index in May. April's 16.8 reading is unlikely to be matched given the evidence of reports from Richmond, New York and Philadelphia
- Wednesday 31 May: Chicago PMI, which stood at 58.3 in April could also take a hit given the lower readings elsewhere
- Also on Weds, is the Fed Beige Book which reports on current economic situations. The latest economic assessment from the horse's mouth is likely to make interesting reading
Global growth provides optimism
On the upside, economists and market analysts are upbeat on global economic growth. Major US trading partners in the eurozone are witnessing a robust recovery and global trade flows are gathering pace after a sluggish 2016.
In a note from Strategas today, analysts write: "Despite the inverted China yield curve, the China credit downgrade, speculation of a Brazil downgrade, and more evidence of the US 'retail apocalypse', we continue to see evidence of global economic growth with moderate inflation."
The bottom line is, that the Fed is still likely to make its second rate hike this year in June, and will begin reducing its multi-trillion dollar balance sheet, bloated by years of quantitative easing.
The policy path beyond this darkens.