The Fed – Strong Employment Driving The Move – Inflation Not Their Worry – What Is Their Real Worry?

The Fed – What Next?

Most observers expect the Federal Open Market Committee (FOMC) to raise the Fed Funds rate another 25 bps at its June 13-14th meeting. The real question — what then? The strength of the labor market gives the FOMC sufficient underpinning to make further moves. At the same time, many economists express concern about the inability for various measures of inflation to reach higher levels. Unlike these economists, most consumers prefer the current slow increase in the rate of inflation. The result–positive consumer surveys reflecting both strong employment and low inflation outlooks. The positive consumer attitudes should give the FOMC cover to raise the Fed funds rate faster than investors expect.

Labor Market Driving the Fed’s Concerns

In its May minutes, the FOMC showed real concerns about the job market overheating. At that meeting, participants judged that the unemployment rate declined below levels likely to be normal over the longer-run. Further on, the minutes once again refer to a “substantial undershooting of the longer-run normal level of the unemployment rate.”

These comments may hint at a greater urgency by the FOMC to subdue overheating in the labor market. If our view proves correct, then the FOMC could return to a more normal monetary policy at a pace quicker than expressed publicly or that investors expect. In our view, this would imply moving away from a “we’ll see” FOMC policy to one less dependent on future economic reports. Therefore, unlike most observers, we would not be surprised to see the FOMC move somewhat more quickly from an accommodative to a neutral monetary policy.

The Fed’s Real Worry – Reloading its Weapons

By moving more rapidly, it would enable the FOMC to reload the weapons it will eventually need to deal with both potential excesses in the economy and a future slowdown. At present,those tools do not contain sufficient ammunition to attack these future likely concerns.

Fed and Investor Complacency – Stay Alert!

The continued complacency of financial markets indicates our expectation for a steadier rate of Fed Fund rate increases does not factor into most investors thinking. Until monetary and economic signals show up contrary to current expectations, the financial markets will continue their state of complacency.Nonetheless, stay alert for change!