Doveish Hawks ? Hawkish Doves ? The future's got a bit cloudier for the Fed .....
ref : "Why a Hot Jobs Market means the Fed Is Facing a Sticky Summer" , Bloomberg Markets
If you're wondering how the S&P 500 Index got to post a record close last night, you can put it down to the release of the minutes of the Fed meeting on May 2-3. At first glance, confirmation that the Fed Open Market Committee were keen to hike rates at their next gathering on June 14th would not seem to be overly bullish for stocks -- unless it represented a reaction to strong growth ..... which on this occasion, it doesn't.
The Fed's stated intention to raise rates twice more this year starting next month is just about still intact, driven in large part by an extremely tight labour market and expectations of its usual consequence -- Inflation. The probability of a June hike is now 83% after the release of the minutes, according to Fed Fund futures prices. But then again, it wasn't far short of that before the release and the mildly enhanced likelihood of an imminent rate increase did not adversely affect the markets. On the contrary, whilst Fed members were happy to describe the unexpectedly soft economic data as "transitory", one or two of them were keen to see evidence of that in upcoming numbers. It was this note of caution with regard to the future rate path beyond June that encouraged equity buyers.
It's quite possible that Fed policy, with its rigorous attention to the employment data, might get a little confused in the coming months. The Fed, along with most central banks and economists the world over, are adherents of the Phillips Curve theory. You know it well, but just for good order's sake it states that the unemployment rate has a direct and inverse relationship with the inflation rate -- i.e., if unemployment goes down, inflation goes up, and vice versa. If it sounds as though it makes sense, that's because it does and it's why it's almost become a law in economics.
Recent evidence is suggesting however that the Phillips Curve theory, if not exactly breaking down, may struggle to represent what may be a looser relationship between unemployment and inflation than it was in the past. This may be down to specific issues with the labour market such as demographics and working practices, but take last month as an example : April US unemployment fell to 4.4%, the lowest for 10 years and below what most (inc. the Fed) would say reflected full, effective employment, whilst the core inflation rate fell from 2.3% to 1.9%. If you're making policy on the back of jobs data and its perceived effects for inflation, and all of a sudden that relationship stumbles, then it may be wise to at least reconsider that policy.
Many people were keen to find out whether the Fed had taken into account the fiscal stimulus that the new administration has planned for the economy. It was mentioned, but effectively the central bank has dead-batted such inquiries on the grounds that they can only deal with what's in front of them, and cannot speculate on what kind of package may or may not be implemented by the government down the line.
That seems like an eminently sensible position. Apart from anything else, if they made public pronouncements about what how their policy might change if the President manages to enact his economic agenda, then presumably they'd also have to tell us what they might do if it all comes crashing down around his ears. Sensitive soul that he is, we're not sure that Mr Trump's already strained relationship with Fed Chair Janet Yellen could survive an examination of that kind of "what if" scenario.