Hawks make a stand at April Fed meeting, but doves still rule

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Wall Street is at least beginning to entertain the thought that rates may rise a time or two this year, though fear of the Fed remains low.

Prior to Wednesday's release of the April Federal Open Market Committee minutes, the Street was skeptical that some of the recent tough talk would lead to action.

The prevailing sentiment was that all of the Fed jawboning was likely just that — talk, trying to make sure the market doesn't get too complacent about the possibility of tightening at some point this year, according to multiple experts on the Street who believe the likelihood of a June move remains low.

The minutes indicated a sentiment on the FOMC that should economic data continue to progress, a June hike would be "appropriate." However, the market's heard that chorus from the Fed before — that policymakers are "data dependent" and will react as conditions warrant.

Market experts believe that economic reports between now and the June 14-15 FOMC meeting would have to be pretty much pristine to move the prevailing dovish voting bloc off its position.

"If every single one of those was a report that was way stronger than expectations and showed the slack in the economy had been taken up at a rapid pace here in the second quarter, then all else being equal the Fed would probably raise rates in June and sit back and wait. That's barring any kind of January- or February-like global disruptions," John Canally, chief economic strategist at LPL Financial, said in an interview. "Do I think that's likely to happen? No."

The hawkish contingent of Fed members would like investors to believe otherwise. FOMC members John Williams, Loretta Mester and James Bullard have been pushing the theory that conditions are ripe for at least two hikes this year.

So what gives?

"They're just trying to say, 'Listen guys, we're serious. We're going to raise rates twice this year,'" Canally said. "A lot of it is nudging. The Fed doesn't want to surprise the market."

Heading into the release Wednesday of the April minutes, and less than a month out from the June session, the market was pricing in a little stronger chance of a tighter Fed this year. The meeting summary changed that.

The probability for a June hike stood at 17 percent by midday but popped to 30 percent after being at just 1 percent a month ago. July was at 48 percent — nearly a coin flip — while September showed a 64 percent reading, up from 46 percent earlier in the day. Still, the market was pricing in just a 29 percent chance of two rate increases this year, and even the first hike isn't fully priced in until February 2017.

Markets took a jolt from the minutes release, with the Dow surrendering a 100-point gain and interest rates jumping.

In arriving at the final decision, Fed Chair Janet Yellen and her dovish majority have a plethora of data points to consider. But while the market focuses on the usual suspects — nonfarm payrolls, housing starts, retail spending, GDP and the consumer price index to name five — there exists a slew of less-noticed indicators that also could influence decision-making.

A glance at a few:

  • Sticky price CPI: This is an obscure one, but it's nonetheless significant. The Atlanta Fed's index measures components in the consumer price index that tend to fluctuate less, or are "sticky." The most recent reading, on May 17, is up 3.1 percent. That's above the Fed's 2 percent inflation target and hawkish for rate hikes.
  • National financial conditions index: This takes myriad conditions, including prices on financial markets, credit conditions and leverage. A reading above 1 indicates tighter-than-normal conditions. The most recent reading is -0.64 percent, which is unchanged from a month ago, looser than three months ago, but tighter than six months ago. Overall, the reading is slightly dovish.
  • Employment cost index: This is a Labor Department measure of salary and compensation. The first-quarter reading showed an annualized gain of 1.9 percent, which contradicts the Atlanta Fed's wage growth tracker (see below) and is dovish (and is considered by Fed watchers to be a Yellen favorite).
  • Productivity: This is a more conventional data point, but may be the one figure holding back the economy most. The first-quarter reading showed a decline of 1 percent. Deutsche Bank economists Aditya Bhave and Joseph LaVorgna believe it will "remain suppressed in the near term. Our analysis suggests that as a result, the Fed will maintain its dovish stance for much of this year."
  • The Atlanta Fed's wage growth tracker: A reading of data from the current population survey, the April reading showed a 3.4 percent gain, the highest since February 2009, which is definitely hawkish.

Between now and the June meeting there will be, of course, dozens of relevant reports. However, on balance the Fed has shown a tendency to exercise caution and to err on the side of dovishness.

In fact, investors may be wise to, as one strategist put it, "discount" all of the hawkish saber-rattling.

"Chairwoman Yellen controls the majority opinion of the FOMC," Brian Rehling, Wells Fargo's co-head of global fixed income strategy, said in a report for clients. "Fed watchers would be well served to focus on messages that emerge from her voting bloc rather than put too much stock in the more hawkish members who lack the majority to implement their policy positions."

Rehling believes low inflation will override the Fed's projections, which are for two rate hikes this year and "rather unreliable" historically to boot. He sees just one rate rise in 2016.

"It would most likely take a meaningful move higher in inflation expectations or a change in message from the FOMC's core dovish members to change our rate-hike expectations," he said. "Until then, we believe that investors should expect, and position for, a 'lower for longer' interest rate environment."