US: The final nail in the coffin for a June hike? - ING

James Smith, Economist at ING, suggests that the last week’s dismal labour report and ISM Non-manufacturing have cast serious doubt over the potential for a near-term rate hike, with Chair Yellen's speech today key in determining the degree to which this will affect policy in June and beyond.

Key Quotes

“Over recent weeks, the blocks appeared to have been gradually falling into place for another rate hike from the Fed, but the latest labour report has potentially put a large spanner in the works.

FOMC members could look at this report in one of two ways. The more optimistic explanation is that job creation is slowing as the economy reaches something close to full employment and erodes the last remaining slack. Alternatively, one could see it as evidence that weakness emanating from business investment side of the economy since the start of the year is starting to filter through to the more lagging labour market.

Although FOMC members will want to avoid interpreting one month’s figure (particularly as non-voter Evans said earlier, the strike means it is harder to analyse), the downward revisions to earlier readings will mean that, at the very least, the more dovish FOMC members will want to see further evidence before making any conclusions.

In our opinion, this may well put the final nail in the coffin for a June hike, with confirmation of this potentially coming from Chair Yellen's speech on Monday (16:30 GMT). Of course, the labour market is not the only area the Fed is looking at, and up until now, we had felt that the factors constraining Fed normalisation lay elsewhere. Since the start of the year, financial conditions have stabilised and one of the key questions facing FOMC members more recently has been how strong they perceive the recovery in the activity data (excl. labour market) to have been since the weak first quarter.

This data-dependency element of the FOMC’s reaction function was dealt a second blow on Friday by a large dip in the ISM Non-manufacturing index.

Putting this and the payrolls figure aside for a moment, we have noted recently that a June hike potentially looked unlikely purely because the FOMC will be keen to wait until the “known unknown” of the UK EU referendum has passed (which could potentially impact upon US financial conditions).

In effect, the question facing the FOMC in June will be “would delaying a hike until July/September be mistake?” Given the Fed’s long-held preference for a gradual pace of normalisation, we think that the answer is probably “no” (as emphasised by recent Fed comments and the latest set of minutes), especially now that many Fed members will want to see the next one or two labour reports before seeing if a July/September hike is a viable option.”