US: An eternity between now and July – RBC CM

Research Team at RBC Capital Markets, suggests that while recent Fed rhetoric and a surprisingly hawkish set of Minutes for the April meeting have certainly forced implied rate hike probabilities higher throughout the 2016 horizon, RBC still think it is nearly impossible for the committee to raise rates in June.

Key Quotes

“Additionally, we think a lot of things have to align in order for the Fed to justify a lift at the July confab. September is still complicated by Money Market reform and November (the meeting is on the 2nd) falls right on top of the US Presidential Election. So despite events of recent days, our core view is that the most likely timing for the next hike is December. That being said, we also acknowledge that many committee members seem to now view July as an attractive candidate for raising rates.

Despite the significant “talking up” of June as a live meeting, we think this was merely an effort by the Fed to regain control of the “option” to hike if they felt the need. With the Brexit vote in the ensuing week and polls in many cases still within the margin of error (and with a sizeable “undecided” share to boot), the Fed cannot at this juncture risk a hike that is followed by a “leave” vote. They would effectively risk the mother of all policy mistakes for the negligible benefit of tightening just 1.5 months ahead of the next meeting.

July, however, is becoming a very viable option. The Brexit outcome will be known by then, and it is far enough away from the implementation of Money Market reform that the committee will not have to worry much about adding another layer of complexity to what could be volatile short-end markets (this makes a September hike a remote possibility, in our view).

From a “messaging” standpoint, note that the advance read of Q2 GDP is due out just two days after the July meeting. The committee will by then have a pretty good handle on what the quarter will look like—a constructive GDP report that follows a rate increase that closely would make for very good optics indeed (especially in the weekend press).

But while a Q2 GDP profile near our forecast of 3.2% and a continued drift up in inflation would justify the “domestic” conditions for a July hike, we also have to be mindful that what has derailed the tightening cycle recently has not been homegrown. We will need global developments to cooperate and will have to gauge any negative ramifications from further potential upside to the US dollar/US interest rates from the recent shift in Fed tone that could cause capital flow disruptions to re-emerge.

The broad USD still remains more than -4% off the 2016 highs but has retraced +3.5% from the late April lows (which coincided with what was at the time perceived to be a dovish April FOMC!). Policy divergence has not been well met by global markets and we are more than 2 months away from the July FOMC meeting—an eternity by today’s standards.”