Reports clear way for rate hike
INDICATOR: May Producer Prices and Small Business Optimism
KEY DATA: PPI: 0 percent; Over-Year: +2.4 percent; Goods: -0.5 percent; Energy: -3 percent; Services: +0.3 percent/ NFIB: Unchanged
IN A NUTSHELL: “With inflation at reasonable levels and small businesses optimistic, Wednesday the Fed can do what it is expected to do, which is raise rates again.”
WHAT IT MEANS: The Fed started its two-day meeting Tuesday and it would take a blockbuster number for the Fed to change course. Tuesday’s reports don’t qualify as they were in line with what we all know and expect from the data: Inflation is not a threat but business leaders are exuberant. Wholesale costs were flat in May as declining food and energy prices offset moderate increases in other goods and services. Excluding energy, goods costs were up moderately with the pace over the year pretty much at the Fed’s target. Indeed, if you look at the details and the special indices, most rose since last May by somewhere between 1.5 percent and 2.5 percent. In other words, at least when it comes to producer prices, inflation is right where it needs to be for the Fed to make any move it wants to make.
If inflation is pretty much on the mark, what about growth? The disappointing first quarter will likely be followed by a better second quarter. But going forward, it will take businesses expanding more aggressively to move the expansion into higher (not necessarily high) gear.
If you believe the business optimism numbers, the corporate sector is ready and willing to do its part. We already knew that CEO confidence was soaring and that exuberance is being matched by small business owners.
The National Federation of Independent Business’ Confidence index was flat in May. However, that is misleading. It remained near record highs. Respondents think it is a great time to expand and they are extremely hopeful that business conditions and earnings will improve. They are hiring and hope to hire more workers, but they cannot find qualified applicants. No surprise there.
MARKETS AND FED POLICY IMPLICATIONS: The Fed will announce its decision tomorrow afternoon and we are likely to see another tick up in rates. The markets have given the FOMC a free pass so it might as well take it. But it isn’t just the funds rate that will be watched. It is clear the members want to start reducing the Fed’s balance sheet and we need to look for any signals on when that might start. We need to also watch for indications that the process of normalization will continue on a consistent basis. The view on the economy is important in making any judgment on how many more times the Fed may move this year.
Tuesday’s data should have made few waves with investors. It’s Wednesday’s statement, press conference and economic projections that most people will be watching closely.