Why the Fed’s Job is All the More Complicated

The Fed revealed in its latest statement that it will take a more dovish approach to normalizing its federal funds rate, but still left the door open to some degree that an increase could happen later this year. It’s a night-and-day juxtaposition from the central bank’s stance in December, both as a result of domestic considerations and international concerns. Six months on, we believe that accurately judging the Fed’s next move will require paying attention to jobs growth, inflation expectations and corporate profits here at home. We’ll also be keeping a close eye on conditions abroad—particularly in China, which remains the most important aspect of global economic growth.

The (slow) road to a rate hike

As you can see in the chart below, the Fed’s forecast for its median rate continues to tick lower.


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A closer look at key economic data provides strong support for the decreased target. May’s employment data, coupled with disappointing revised numbers for April and March payrolls, shows us that jobs growth has yet to moderate this year. We know that payrolls tend to track corporate profits quite closely; as profits continue to roll over, we expect to see weaker jobs numbers follow suit.

Headwinds for other sectors

In addition to employment data, we’re keeping a close eye on two particular sectors: leisure and hospitality. While both provided the strongest sources for job growth in recent years, we expect this to taper off. The reason? Higher wages sparked by a tight labor market and higher minimum wage mandates in several states. When wage increases are a result of policy instead of market mechanics, revenues and profits can suffer if businesses cannot offset the costs by charging higher prices. The net result could be decreased hiring in these aforementioned areas.

So when will a rate hike happen?

If jobs growth continues to slow, inflation expectations and realized inflation remain moderate, and both domestic and international political risks continue to roil markets, we expect rate normalization will be difficult for the Fed to accomplish. Unless we see a significant improvement in these areas, we will likely only see one — or at most two — rate hikes in 2016. It could happen as early as next month, but we think the last third of the year is more likely.

(c) Blackrock Investment Management



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