Why the Fed’s job is all the more complicated

The Federal Reserve’s latest meeting revealed the central bank’s more dovish path to further normalizing interest rates. Rick Rieder explains what’s complicating the task at hand.

The Fed revealed in its latest statement that it will take a more dovish approach to normalizing its federal funds rate, but still left the door open to some degree that an increase could happen later this year. It’s a night-and-day juxtaposition from the central bank’s stance in December, both as a result of domestic considerations and international concerns. Six months on, we believe that accurately judging the Fed’s next move will require paying attention to jobs growth, inflation expectations and corporate profits here at home. We’ll also be keeping a close eye on conditions abroad—particularly in China, which remains the most important aspect of global economic growth.

The (slow) road to a rate hike

As you can see in the chart below, the Fed’s forecast for its median rate continues to tick lower.

chart-median

A closer look at key economic data provides strong support for the decreased target. May’s employment data, coupled with disappointing revised numbers for April and March payrolls, shows us that jobs growth has yet to moderate this year. We know that payrolls tend to track corporate profits quite closely; as profits continue to roll over, we expect to see weaker jobs numbers follow suit.

Headwinds for other sectors

In addition to employment data, we’re keeping a close eye on two particular sectors: leisure and hospitality. While both provided the strongest sources for job growth in recent years, we expect this to taper off. The reason? Higher wages sparked by a tight labor market and higher minimum wage mandates in several states. When wage increases are a result of policy instead of market mechanics, revenues and profits can suffer if businesses cannot offset the costs by charging higher prices. The net result could be decreased hiring in these aforementioned areas.

So when will a rate hike happen?

If jobs growth continues to slow, inflation expectations and realized inflation remain moderate, and both domestic and international political risks continue to roil markets, we expect rate normalization will be difficult for the Fed to accomplish. Unless we see a significant improvement in these areas, we will likely only see one — or at most two — rate hikes in 2016. It could happen as early as next month, but we think the last third of the year is more likely.

 

Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Global Fixed Income and is a regular contributor to The Blog.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of June 2016 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

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