After months of dovish rhetoric that implied near-zero interest rates would be here to stay for even longer, the Federal Reserve has seemingly reversed its tune to a more hawkish note. We've seen some initial reactions in the markets to this shift, but it's true that Fed has a habit of engaging in misdirection. The question remains: When will the central bank act on its plan to begin normalizing interest rates?
Lack of Communication
The Fed has turned the rhetorical game of swaying markets (through tantalizing hints as to its intentions) into high art. Ever since the days of former Fed Chair Alan Greenspan (1987-2006) and "Fedspeak," the central bank's board of governors has actively engaged in public discourse surrounding its policies and plans. However, this discourse is obviously unduly influenced by the policymakers themselves.
Several "Fed Watchers" have pointed out that there is a growing disconnect between the central bank and the markets due to a lack of clear communication. This is part and parcel of the Fed's strategy for keeping market participants on their feet, so to speak. However, this sort of rhetorical cat-and-mouse doesn't always lead to positive consequences. Markets may get overheated if the Fed is too dovish, or could crater worse than is necessary because of an especially hawkish tone from the Fed.
Summer FOMC Meetings
With this in mind, we may see some surprise in the markets if the Fed does indeed choose to raise the federal funds rate at either of its summer meetings of the Federal Reserve Open Market Committee (FOMC). Several analysts have pointed out that while the Fed is seemingly raising the alarm about a rate hike coming soon, the markets have been slow to adjust to that reality.
Then again, with some officials suggesting there could be as many as seven rate hikes between now and the end of next year, it's understandable that the markets are wary of being burned by Fedspeak again.
Until very recently, the markets were pricing in virtually no chance of interest rates going up this summer. Yet, the odds of a June rate hike quickly jumped over 25% while the markets placed the chances of a July move at a robust 53%. Today, those numbers are even higher, at 36% and 59%, respectively.
There are a few interesting factor to consider in whether or not the Fed makes a move on interest rates this summer. (Apparently, the macro picture of the world economy and the pace of GDP growth in the U.S. will not be among them.) The FOMC has claimed that it will be data dependent and is leaning toward raising rates unless the data gets worse. However, the June committee meeting comes just before the "Brexit" vote in the U.K. The chance that Britain indeed leaves the E.U. and this "black swan" disrupts the markets should weigh heavily on the decision to raise rates.
Additionally, June's FOMC meeting is followed by a press conference while July's meeting doesn't. The markets have largely assumed that the Fed will only raise rates at meetings with a press conference, but this unofficial trend may not continue indefinitely. Don't be shocked by a "summer surprise" by the Fed in July!
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