Upcoming Clues Regarding a Fed Rate Hike

Did Yellen point to a March rate hike in her Semi-Annual Monetary Policy testimony, by saying it may be better to tighten sooner rather than later?   Or, was it just a throw-away comment, representative of the standard Fed line that all meetings are "live"?  These questions will probably be a focus of market commentary in the next few weeks.  The markets will likely examine the January 31/February 1 FOMC Minutes and upcoming US economic data for clues.  My guess is these clues will not significantly change market expectations for the March FOMC Meeting -- allowing the stock market to rally further and Treasury market to stay in a trading range over the next few weeks.  But, it is conceivable the Fed might decide at the March 14-15 meeting that non-economic reasons on top of the broadly strong macroeconomic background justify a hike -- either at that meeting or signaled then for the May meeting -- regardless of what printed in the prior few weeks.  

Even if the Fed hikes in March or signals one for May, the stock market reaction should be muted -- and any pullback temporary -- for a couple of reasons.   A hike would fit with the Fed's forward guidance, so is at least partly built in -- assuming the Fed does not change the forward guidance in its "dots" chart.  Also, the strong Q117 economic background and the expectation of future fiscal stimulus remain an offset to the tightening. 

Evidence in the January 31/February 1 FOMC Minutes
This week, the markets will likely focus on the Minutes of the January 31/February 1 FOMC Meeting (due February 22) for a clue as to the significance of Yellen's comment.  The Minutes may suggest it was a throw-away comment.  Inasmuch as the notion of "sooner rather than later" was not included in the FOMC Statement, the idea presumably was not generally agreed to be of imminent importance at the meeting.  And, Yellen's testimony might have been prompted by the strong January Payroll gain, which had not been released at the time of the FOMC Meeting.

But, some subtle changes to a key sentence in the Minutes would be a hawkish clue.  The key sentence can be found in the Minutes of the December 2016 FOMC Meeting.  It shows that tightening at a faster-than-gradual pace was viewed  by participants as more of a possibility than a likelihood:  "Several members noted that if the labor market appeared to be tightening significantly more than expected, it might become necessary to adjust the Committee’s communications about the expected path of the federal funds rate, consistent with the possibility that a less gradual pace of increases could become appropriate."

A repetition of this sentence in the January-February Meeting Minutes would suggest that Yellen's comment was a throw-away, although the fact that she said it suggests that she was one of the "several" members expressing this view at the meeting.  Her testimony would take on more significance if this sentence were strengthened.   For example, "many" could replace "several," "may" or "would" could replace "might," "likelihood" could replace  "possibility," or "would" could replace "could."   Yellen used the word "would" in her testimony:  "As I noted on previous occasions, waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly...." But, it is not clear whether this means the sentence in the Minutes was changed.

Evidence in Upcoming US Economic Data 
The markets also will likely weigh the economic data released over the next few weeks for clues regarding a March rate hike.  While most of the upcoming data should be strong enough to justify a tightening, some important ones -- February Unemployment Rate and Average Hourly Earnings -- may not. 

The February Employment Report (due March 10) will likely show a good-sized gain in Payrolls, helped by the warm winter.   But, Average Hourly Earnings and the Unemployment Rate may be more benign, as was the case in January -- and these parts of the report could be key to whether the Fed hikes in March. 

         a.  Calendar considerations suggest a modest 0.1-0.2% m/m for February Average Hourly Earnings -- which would raise the y/y only slightly to a still-low 2.6% from 2.5% in January (both below the 2.8% 2016 pace).  

         b.  A steady or higher Unemployment Rate would suggest that the "supply-side" of the economy is expanding to accommodate strong growth -- and that restraint on demand from a Fed rate hike is not needed.  But, there is no reliable evidence regarding the m/m direction of the Unemployment Rate.  So, market uncertainty regarding a Fed rate hike may persist at least into March 10.

The February Markit Mfg PMI (due February 21) will be noteworthy since it has correctly predicted the direction of the important Mfg ISM in each of the past 6 months.  Consensus looks for an uptick.  But, even a dip in either Index would keep it at a high level, keeping alive the possibility of a rate hike.  

Non-Economic Reasons for A Hike
The Fed still may decide to hike in March despite the macroeconomic evidence not being entirely persuasive, as the decision may boil down to non-economic reasons.  The Fed might find tightening in March politically desirable before it can be interpreted as in opposition to the proposed fiscal stimulus.   Or, Yellen may be willing to take the heat in her last year as Chair.

In any of these cases, the background of a strong economy in Q117 could serve as an excuse to tighten, even though some of the strength may be weather-related and thus temporary, the Unemployment Rate may have stopped falling, and inflation is under control.  Both the Atlanta and NY Fed's models project above-trend GDP growth in Q117 (Atlanta 2.4%, NY Fed 3.1%, trend 1.5-1.7%).  The Fed could say that economic growth is in line with its expectations, so that a hike is consistent with its gradual approach to tightening.