Will Next Week's US Economic Data Lower the Odds of a June Fed Rate Hike?

Next week's key US economic data -- March Mfg ISM and Payrolls -- will probably not significantly lower the odds of a June hike, even though they are expected to soften.  Near-consensus prints still would be strong.   Substantially softer-than-consensus prints would likely prompt Treasury yields to fall, dollar to weaken and perhaps stocks to climb.  But, these easier financial market conditions would be a positive for the economic outlook and could encourage Fed officials to dismiss the weakness as temporary (possibly in subsequent speeches).   As NY Fed President Dudley said in a speech on March 30, the easing of financial conditions after the December 2016 rate hike added to reasons to hike again at the March 2017 FOMC Meeting.
 
Next Week's US Economic Data
Prints near the consensus estimates for the March Mfg ISM and Payrolls should keep the odds high for a June Fed rate hike, regardless of how financial market conditions react to the reports.  Consensus looks for a dip in the Mfg ISM to a still-strong 57.0 in March from 57.7 in February, keeping it well above the 53.3 Q416 average.  Consensus also looks for March Nonfarm Payrolls to slow modestly to +180k m/m from +235k in February.  The underlying job pace would remain well above the 75-125k pace deemed consistent with underlying labor force growth.  And, it would suggest the temporary factors that may have boosted job growth in January-February -- the warm winter and catch-up after post-election cautious hiring in Q416 -- were not significant:  job growth just has been strong.  So, even if financial markets tighten on the jobs report, the economy's strength would seem to be enough to keep a June rate hike in play.

But, if the jobs data are substantially below consensus -- which is my guess -- and Treasury yields fall notably, stocks rally and the dollar falls in the belief that odds of a June rate hike have diminished,  the resulting easing in financial market conditions could be a Catch-22.  The Fed could view the easier conditions as ensuring that the March payback in the data is temporary, and thus not change its view of a gradual tightening in monetary policy that could include June.  Note that a March Payroll increase in the 100-125k range is not out of the question, as that would bring the Q117 m/m average in line with the +192k m/m H216 average.

What Could Stop the Fed
Recent Fed speeches have underscored officials' desire to bring the funds rate closer to its longer-run level.  So, it will likely take a lot to stop the Fed from hiking at least two more times this year.  Two possible reasons for the Fed to delay tightening would be a sharp drop in financial conditions and/or a sharp slowdown in economic growth and labor market improvement. 

Dudley discussed the usefulness of financial conditions as both a reflection of expectations of future growth and a propellant of growth.   So, tighter conditions -- weaker stocks, higher Treasury yields and stronger dollar -- would be viewed as a negative development for the economy.  To be sure, tighter financial conditions would not necessarily result in slower growth, as Dudley pointed out from the 1987 stock market crash experience.  But, it still could hold back the Fed from tightening. 

The most important US economic data to monitor the strength of the economy/labor market are Initial Unemployment Claims.  These are the broadest high-frequency evidence on the economy that is available, and they are a universal count -- not subject to sampling issues.  Initial Claims have begun to move up, as predicted on the basis of a payback for the temporary factors that supported the labor market in January-February.  But, the question is whether they will continue to climb into the Spring.  A sustained uptrend in Initial Claims could give the Fed pause in considering another rate hike at the June FOMC meeting -- although not necessarily if financial market conditions are easing.  A reversal to the downside in Initial Claims -- or even a leveling off -- would encourage officials to move again.  Note that they moved down in January and February ahead of the March rate hike.

                                         Initial Claims (level, 000s)
       March 25 Week                    258
       March 18 Week                    261
       March 11 Week                    246
       March 4  Week                     243

       Feb Avg                                234    
       Jan  Avg                                243

       Q416 Avg                             256