Last Week: Another week of market moving, surprise news, as Wednesday’s release of minutes from April’s FOMC minutes showed most Federal Reserve policymakers believed an interest-rate hike would be appropriate in June if the economy continued to improve, but were divided over whether those conditions were likely to be met in time.
After a weak Q1, many recent economic measures are signaling a turnaround for Q2. A surprising spike in inflation, recent signs of growth in housing and consumer spending and expectations for Q2 GDP to expand to 2.5 after a dismal 0.5% in Q1 lifted investor expectations for the path of rates this year. As such, the market’s expectation of a June hike remained low, at about 28 percent, but climbed steeply from a pre-Fed minutes level of 14%.
The 10-year Treasury traded higher by 8bps to 1.8384%, while 1-month LIBOR traded higher by 4bps to 4433%.
This Week: Financial markets are now splitting their attention between two types of events: Fed commentary and economic data as driven by the Fed’s “data-driven” mandate.
The US weekly data calendar is on the quiet side, and while the majority of releases should show modest improvement, we’re not looking for any major shocks. Look for measures on New Home Sales, April’s Trade Deficit, Initial Jobless Claims, Durable Goods Orders and the highlight of the week, the second read of Q1 GDP, which should be revised up to 0.9% from 0.5%, to dominate economic headlines.
Behind the data drip, technicals, the global backdrop, as well as the behavior of real money and it’s effect on the yield curve will be the main drivers of the week. Fed speakers will garner more attention than usual based upon last week minutes, Chair Yellen’s Harvard speech on Friday in particular.
After Yellen’s speech on Friday, the market will shift its attention to this weekend’s G7 meeting. We’ll be looking for signs of policy accord among the world’s leaders versus the monetary policy free for all we’ve seen thus far.
Take-Away: Unless the bottom falls out of equities, we doubt we’ll see any steep decline in yields for now, due to improving economic data and a Fed that looks be leaning more toward a near-term hike than not. A steady/declining unemployment rate, jobless claims sticking to their recent range and inflation ticking higher towards the Fed’s 2% target continue to be the gauges we watch closely, and all are pointing toward a summer Fed hike. We think the probability of a Fed hike in June is higher than the 28% currently priced into markets, but is still likely below 50%. We see a greater than 50% probability of a Fed hike in July however, and forecast two quarter-point moves this year and three next year, for a total of 125 basis points by the end of 2017. Conversely, markets are pricing in just 50 basis points of tightening by the end of 2017.
The FOMC meets again on June 14-15, and Chair Yellen will discuss the decision in a press conference as she does every other meeting.
Current Market Rates: