Odds Rise for a June Rate Hike

A 'measured' approach by the Fed, which stood pat Tuesday, probably precludes anything more sudden.
Author:
Publish date:

Updated from 3:52 p.m. EDT

The

Federal Reserve's

policy statement Tuesday leaves open the possibility for a rate hike as early as June, several economists said Tuesday.

"The Fed has declared it's ready to tighten," said Asha Bangalore, U.S. economist at Northern Trust.

The central bank removed its pledge to remain "patient" in hiking rates Tuesday but said policy accommodation can be removed at a "pace that is likely to be measured."

"I'm not sure what that means," Bangalore said. "It probably means they won't do 50

basis points or 75, but I don't know. It definitely means they're doing something in 2004."

Tony Crescenzi, chief bond strategist at Miller Tabak, said that in using the word "measured," the Fed is trying to draw a link between economic data and policy formulation.

"The word 'measured' means the Fed won't act preemptively but will move only in response to data," he said. "The Fed left the door open for a move on June 30."

Although the Fed has hinted that a rate hike is coming, its language suggests that a repeat of 1994 probably isn't on the cards. Ten years ago, the central bank embarked on a series of rate hikes, sending the fed funds rate up to 5.5% in November 1994 from just 3% at the start of the year.

Fed funds futures contracts are now pricing in a 48% chance of a 25 basis point rate hike in June, up from 44% yesterday. Financial markets are fully pricing in a rate hike in August and 50 basis points of tightening by year end.

As was widely expected, the central bank left official interest rates on hold at 1% Tuesday but made several important changes to its policy statement. The Fed adopted a neutral bias on inflation and said hiring "appears to have picked up." In its last statement on March 16, the Fed said the probability of disinflation was almost equal to that of a rise in inflation and it said new hiring had "lagged."

John Lonski, chief economist at Moody's, said he is advising clients to prepare for a rate hike next month.

"If payrolls were to grow by 200,000 per month for the months of April and May and if core CPI inflation monthly reading were to average at least 0.2%, the Fed might go ahead and decide to hike rates as early as June 30," he said.

The employment report for March showed that 308,000 jobs were added to the economy. Economists believe that 165,000 jobs were created in April. The next nonfarm payroll report will be released on Friday.

"The committee continues to believe that an accommodative stance of monetary policy, coupled with robust underlying growth in productivity, is providing important ongoing support to economic activity," the Fed said in its statement. "The evidence accumulated over the intermeeting period indicates that output is continuing to expand at a solid rate and hiring appears to have picked up."

The Fed also noted that the risks to the goal of price stability have moved into balance. "Although incoming inflation data have moved somewhat higher, long-term inflation expectations appear to have remained well contained," it said.

The consumer price index rose a larger-than-expected 0.5% in March. In addition, the Fed's preferred measure of inflation, the personal consumption expenditure price index, rose 3.2% in the first quarter after a 1% rise in the fourth quarter. The core PCE index rose 2% compared with 1.2%.

Still, economists note that the PCE index is up only 1.4% year over year, which is at the low end of the Fed's tolerance range of 1% to 2%. Moreover, pundits say sluggish wage growth is keeping costs down at many U.S. firms.

"By no longer saying it can be patient in removing its liquidity policy, and by recognizing that 'inflation data have moved somewhat higher,' the Fed has opened the door for a rate hike as early as June," noted Ashraf Laidi, chief currency strategist at MG Financial Group.

Stocks were generally higher, with the

Dow Jones Industrial Average

up 3 points to 10,317 and the

Nasdaq

up almost 12 points to 1,950. Bonds were generally lower, with the yield on the 10-year note rising to 4.54%. Many participants had been expecting the Fed to lay the groundwork for a rate hike Tuesday and the new policy statement didn't come as a surprise.