The Federal Reserve is a cautious beast at the best of times, and under the Chairmanship of Janet Yellen, this vigilance has continued. 2013 was a particularly difficult year for the Fed with the “taper tantrum” subduing the efforts of the Federal Open Markets Committee to clearly communicate when it would start to bring about a reduction in its quantitative easing stimulus package.
When the then Fed Chair, Ben Bernanke, announced that the Fed had begun to think about reducing the $85bn a month, emerging market currencies were smacked around by the markets as they begin to price in higher yields on US debt and a stronger USD, whilst equities took a swan dive globally. The economic back-drop to the announcement was all the more strange. Growth was poor, the unemployment rate was above 7% and inflation was low. The Fed rowed back at their August 2013 meeting, surprising the markets by not tapering purchases, and instead waiting until December to do so.
This precedent has continued to influence decision-making at the Fed up the present day. It is a route cause of the caginess you will still find when members are asked to talk about the prospect of higher interest rates in the near future. The most recent Fed press conference showed an FOMC that is still very much unsure about the resilience of inflation, growth and job market dynamics in the current US economy.
We were surprised about the great lengths Yellen went to when attempting to play down the inflation picture at the last Fed meeting. Inflation expectations were hardly revised at all in the latest round of economic projections, with the key takeaway being that inflation numbers throughout to 2016 are expected to remain below the Fed’s target of 2%.
However, this week’s jobs market release, moved to Thursday from Friday’s Independence Day holiday, can start to increase these near-term rate expectations. The most confusing balancing act in financial markets at the moment is how bad US output was in Q1 and how far the economy has rebounded in Q2, leaving the 2nd half of the year a firm foundation for further, positive expansion. A solid job gain in the last month of Q2 can help this.
We are slightly above the market’s expectation of a gain of 210,000 jobs in June with a preliminary expectation of 240,000. We normally like to see a little more data from the month before pinning down a number, but calendar issues are at play. The non-manufacturing ISM is released on Thursday, 90 minutes after the payrolls announcement, and so, in its absence, we will have to use the well correlated preliminary PMI from last week as a substitute. It hit its highest level on record with a decent increase in the employment sub-index.
A month’s data is not enough to shift the curve of expectations, however, and the Fed’s ‘slowly, slowly’ policy will change in (for dollar bulls certainly) painfully incremental phases. They learned last year just how quickly financial markets can and will react to tonal changes.