Updated: 05-24-2016

Regular readers know that we tend to be dismissive of the minutes from an FOMC meeting, because they are generally laced with a lot of viewpoints that are easy to cherry pick to support whatever spin one wants to assign the minutes. Additionally, we also recognize that the minutes are dated when they are released, meaning more economic data and typically more Fed speak has been seen and heard in the three-week period after the meeting was held.

This time, however, we were pleasantly surprised by the understanding that the minutes for the April 26-27 FOMC meeting actually offered some real value for the market.

They did so with the candid assessment that, "Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee's 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June."

This dated line of thinking corroborated the notice served just yesterday by Fed Presidents Lockhart, Williams, and Kaplan that a June rate hike was not out of the realm of possibility, as the fed funds futures market has so complacently discounted. In other words, the more recent view offered by those three gentlemen was validated by the minutes as being more than just token posturing.

Additionally, it was not lost on market participants that hard economic data for the second quarter, as opposed to the soft survey data, has indeed supported the view that economic growth is picking up in the second quarter.

  • April retail sales? They logged the strongest monthly increase since March 2015.
  • April housing starts? They were up 6.6% month-over-month and were stronger than expected.
  • April industrial production? It was up a stronger than expected 0.7%, logging its first gain in three months.
  • April CPI? It saw its biggest monthly increase in more than three years, driving the year-over change in CPI on an unadjusted basis to 1.1% from 0.9% in March.
  • April nonfarm payrolls? Well, they were weaker than expected, but they weren't weak with 160,000 jobs added. Furthermore, aggregate earnings were up a robust 0.8% in April, which is a good portent for consumer spending.

The preliminary reading for Q1 GDP showed meager growth of just 0.5% on an annualized basis. The minutes from the April meeting reveal that some participants were inclined to dismiss that weakness as a measurement problem as opposed to accepting it as an indisputable sign of weak growth. In any event, the Atlanta Fed's GDPNow model certainly points to a pickup in the second quarter, showing a current projection for real GDP growth of 2.5% on an annualized basis.

As noted above, the fed funds futures market has not given a lot credence to the idea of a June rate hike. The Treasury market, however, has been a little more respectful of the possibility, evidenced by the spike in the 2-yr yield to 0.90% from 0.73% a week ago. The U.S. Dollar Index has also been tracking higher over the same timeframe, rising from 93.83 a week ago to its current level of 95.08.

Fed funds futures traders, though, are starting to change their tune. While a June rate hike is still not viewed as the most probable outcome, the probability of a June rate hike has picked up markedly to 34% from less than 4% earlier in the week.

The minutes from the April 26-27 FOMC meeting, therefore, can honestly be labeled a true market mover.

Granted they are dated, yet their value today is in the understanding that the economic data and Fed speak in the interim has gelled with what members were thinking then. In brief, that understanding has made a June rate hike a live and very believable possibility.

That could breathe fresh life again into the so-called policy divergence trade, which benefits the dollar and the financial sector while undercutting dollar-denominated commodities, emerging markets, dividend payers, and the rate-sensitive utilities sector.

Separately, longer-dated Treasury securities could be in for a real bruising if the market starts to embrace the idea that fed funds rate increases are being driven by an accelerating economy since prospective investors will demand higher returns to compensate for inflation risk. No need to jump the gun there just yet, but strikingly, the back end of the Treasury curve was sent reeling following the release of the minutes in a knee-jerk reaction on the other side of what had been a distinct flattening trade.

--Patrick J. O'Hare, Briefing.com

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