Is the Federal Reserve about to raise interest rates?
Stocks have been idling since December, as investors nervously await the inevitable: The first interest rate hike from the Federal Reserve since 2006.
That could come as soon as soon as today as the central concludes its first policy meeting in nine years in which it is considering tightening monetary policy. This a big deal. Everything from mortgage and credit card rates to the flow of debt-funded corporate stock buybacks depend on the Fed's actions.
The debate will center on whether to keep rates near zero, where they've been locked in in place since 2008, when the Fed was forced to use monetary policy to help shore up the country's sagging economic growth following the housing crash.
The decision is complicated by uneven economic growth; mixed inflation messages; healthy job gains but stagnant wages; the drag from a strong dollar; and the knowledge that investors could react harshly to a rate hike as stock valuations remain "stretched," according to Federal Reserve Chair Janet Yellen.
A rate hike this month would be a major surprise. That's despite evidence of a second-quarter economic rebound as shown in the recovery in the Citigroup Economic Surprise Index shown below, which rises and falls based on where the data is coming in relative to analyst expectations.
A September rate liftoff is seen as the most likely scenario at this point. Yet every little detail of new information from the Fed will be parsed for clues as to whether this is true and what comes after.
Here are a few things to keep an eye on today, with the Fed releasing its latest policy statement this afternoon. Yellen will also address the media in a press conference to explain the Fed's thinking.
Aside from the hike/no-hike decision, the next important development will be whether there is movement in the interest rate forecasts of individual Fed policymakers in the Summary of Economic Projections. The SEP, or "dot plot," delivered a bullish surprise to stocks when last released in March after it revealed a less hawkish estimate of where interest rates would end the year. The forecast also brought the Fed's own estimates closer to where the more dovish futures market is.
Michael Hanson at Bank of America Merrill Lynch thinks the updated "dot plot" of Fed interest rate expectations should still pencil in two rate hikes this year and four in 2016, predicting rate moves in September and again in December.
After the dot plot, Wall Street will be watching how the Fed decodes the mixed economic data we've seen so far this year when they update their full-year GDP growth forecast.
Societe Generale economist Aneta Markowska puts the odds of a June rate hike at "virtually zero," citing what she expects to be a downward revision to the Fed's 2015 GDP forecast. Markowska expects Yellen to express cautious optimism on the labor market in her press conference, but also frustration at an ongoing lack of wage inflation and the unevenness of economic growth.
Trying to predict the outcome of a big Fed decision is a fool's errand, but two possible outcomes seem likely.
The first would be a drop to a one-and-done rate hike forecast for the year in the dot plot. That would be a bullish outcome similar to the aftermath of a downward dot plot revision following the March policy meeting as the Fed brings its estimate down to more closely match what futures traders expect (who have been more dovish on the rate path all year long).
The second would involve the maintenance of the two-hike forecast in the dot plot along with acknowledgement by Yellen of the rebound in the flow of economic data. That would be considered bearish for stocks since it would all but ensure the Fed will hike rates for the first time in nine years in September, or possibly even in July. It would also mean the futures market was too dovish in their rate path expectations.
After years of waiting, we're finally about to see whether the economy and financial markets can handle higher interest rates. With stocks in the doldrums for months as traders awaited the verdict, things could soon get volatile.
