The odds for an interest rate hike at the Fed’s June 15th meeting have come off significantly on the back of weak economic data out of the US. The Fed has outlined a “very gradual” glide path for interest rates going forward and explained the overarching dependence of upcoming rate action on incoming economic data, which the Fed has stated, can allow the interest rate policy door to swing in both directions, as needed. Nonetheless, Traders and analysts alike have doubted the terminal rate paths and long term rate projections (the dots) released at the past several quarterly Fed meetings.

The first reading of US GDP arrived weak at 0.80% vs 0.90% (exp) and well below the Fed’s projection of 2.20% for the year of 2016, even post the down adjustment from December’s Fed projection of 2.40%. Manufacturing indices have come off as well, with Empire state at -9.0 vs 9.6 (exp), Philly at -1.8 vs -1.6 (exp), Chicago at 49.3 vs 50.4 (exp), ISM Manufacturing managed to tick up to 51.3 vs 50.8 (exp) but ISM Non-Manufacturing activity was offside at 52.9 vs 55.7 (exp). US Employment provided a major downside surprise, at just 38K vs 160K (exp), after ADP set the stage for an upbeat report two days earlier at 173K vs 156K (exp). The Unemployment Rate ticked down to 4.70% vs 5.00% (exp) from a prior of 4.90%, however the news was overshadowed by the massive downbeat headline number, as traders sided with the divergence in the two surveys by magnitude of change. The persistently weak trend in US economic data followed by the slip in the Payrolls print has ultimately shifted the perceived time horizon for this rate hike cycle out by a few months at the very least, despite the Fed hawks “one-off” language prevalent on the news wires shortly after the report. Inflation crept higher as Core CPI advanced to 2.10% vs 2.20% (exp), the headline measure came in at 1.10% vs 0.90% showing that slack is still evident as low energy prices persist. The Fed’s preferred inflation metric Core PCE arrived in-line at 1.60% well below the Fed’s 2% threshold level and on target with the Fed’s most recent economic projections, but may not be a cause for concern among Fed members at present.

Quarterly FOMC projections from the March 16th Fed meeting places the Federal Funds Rate rate at 0.90% by the end of 2016, implying two hikes by the end of 2016. However, since the release, there has been some notable weakness in the US economy. While most Fed members have sided with the estimates, markets remain doubtful of the projected 2016 terminal rate. Futures markets are currently implying a 2% chance of a hike at the June 15th meeting, down from 36% just after the May 18th Fed Minutes release. At present, the case for a hike at this week’s FOMC meeting remains weak and market participants would be caught off guard if the Fed decides lift the rate. Without a drastic upturn across most major economic measures in the US it remains unlikely that the FED will achieve the policy objective to bring the FFR to 0.90% by the year’s end.

Recent commentary out of the Fed has, largely, has pointed to a pause this time around. Fed’s Yellen (Fed Chair, Dove) alluded to gradual hikes as being appropriate, if economic thresholds have been met and Yellen currently sees the positive points, in the US economy, outweighing the negatives. Comments delivered during Fed Chair Yellen’s Philadelphia speech highlighted an optimistic viewpoint overall, though the emphasis on data dependence has caused market participants to interpret a longer time horizon for rate actions and many no longer see a hike at the June 16th or the July 27th meeting as imminent. Fed’s Yellen has also acknowledged Brexit uncertainties as a factor as well, when deciding to change rates.

Other Fed members, on the wires recently, have taken a similar line, with most emphasizing cautious optimism and an overall lack of commitment to an immanent hike before additional US economic data and Brexit clarity. The Fed’s Arch Hawk Bullard (Voting member), recently alluded to the possibility of a July hike, but did not comment on June rates. Commentary from Fed’s Lockhart (Non-Voting member) emphasized “patience” going forward on the back of recent payrolls data and Brexit tensions. Fed’s Rosengren (Voting Member) explained that while there is evidence of inflation moving towards the Fed’s 2% threshold, it remains important to see if weak Payrolls data will persist or if it was just a one-off. Fed’s dove Brainard (Voting Member) needs more data before she can commit to a hike, still sees slack in the labor market, and has concerns over feedback to the US from the current situation in Europe. Fed’s Evans (Non-Voting Member) sees two hikes for 2016, though he called for more time to allow for EU referendum uncertainties to subside before judgements are made regarding the outlook post June. Fed Watcher Hilsenrath feels that most officials will want to take a wait and see approach until September, when a clearer picture of the US economy will show whether or not recently observed weaknesses will trend or subside.

US Treasury Securities have had a firm bid since the dovish tone swept the marketplace in mid May, T-Note trades 131-24 up from 129-00 lows earlier this month. Yields have come off, uniformly, from the belly of the curve out to the long end, though there has been a substantial back-end-lead-bull-flattener trade, 20bps in the TUT (Tens-Under-Twos). The relief rally in stocks has pared back some of its gains going into the meeting, SP futures trade 2078 off of 2120 highs on pre-meeting jitters. The Dixie trades down to 94.47 from 96.00 highs as the dovish sentiment and Fed rhetoric washes through the marketplace. Gold, has shown a bid tone on the back of safe haven flows stemming from Brexit fears, rate uncertainty in the US, and a weak US Dollar. Gold has ticked higher but failed to break through the 13 handle, set a high of $1286.50, and trades $1281.00 last.

All in all, market participants are expecting the Fed to take a wait-and-see approach are and not expecting an increase in rates this time around. The Fed has taken a dovish line lately, most economic indicators have pointed south, and Brexit uncertainties may support a more patient approach across the next couple of meetings. Traders will be carefully eyeing the Fed’s statement as well as the any updates to the accompanying quarterly projections for further clues into the glide path for interest rates and will be eagerly awaiting clarity on the Brexit vote on June 23rd.

-David Felkai Uptick GMA.

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