Most Federal Reserve policy makers in April said an interest-rate increase would be appropriate in June if the economy continued to improve, but were divided over whether those conditions were likely to be met in time.

“Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen and inflation making progress toward the committee’s 2 percent objective, then it likely would be appropriate for the committee to increase the target range for the federal funds rate in June,” according to minutes of the Federal Open Market Committee’s April 26-27 meeting released Wednesday in Washington.

“Participants expressed a range of views about the likelihood that incoming information would make it appropriate to adjust the stance of policy at the time of the next meeting,” the minutes stated.

Referring to the June meeting, officials “generally judged it appropriate to leave their policy options open and maintain the flexibility to make this decision” based on how the economy evolves, the minutes said.

After a weak first quarter, more recent indicators show a rebound in the second. A bump in inflation reported this week lifted investor expectations for the path of rates this year, though odds of a June hike remained low, at about 14 percent, based on federal funds futures pricing.

Consumer Prices

The consumer price index rose by the most in more than three years in April. Recent data on housing and consumer spending have also indicated signs of growth. Gross domestic product in the second quarter is on pace to expand 2.5 percent, according to the Atlanta Fed’s GDPNow gauge. That’s a pickup from 0.5 percent growth in from January through March.

David Fuller's view

The Fed clearly hopes that it will be able to raise rates in June or more likely July.  If it could do so without fearful hesitation, and that is a big ‘IF’, the strategy of a gradual move towards 2% for the Federal Funds Rate would provide it with some insurance for the medium to longer term.  That would give the Fed more flexibility in dealing with the next recession, whenever that may occur. 

Additionally, the Fed would like to be able to raise rates in the knowledge that the US economy is actually improving.  This would be generally recognised as a validation of the Fed’s cautious strategy to date. 

Nevertheless, despite a perennially uncertain world, the Fed faces more uncertainties today.  For instance, the Fed would be backing UK Brexit polls which currently show the Remain vote with a significant 15-point lead.  While Remain has held at least a slim lead ever since the referendum was announced, this outcome cannot be guaranteed when the next Fed meeting occurs from 14-15 June, ahead of the UK’s 23 June referendum on whether or not to leave the European Union. 

Following an already long wait since last December’s first rate hike by the Fed, a rate increase eight days before the UK’s important vote, which clearly has international implications, would be viewed as a gamble.  This is unnecessarily risky because the recessionary implications of a premature rate hike clearly outweigh the consequences of waiting until July, when the Fed could actually raise rates by 25-basis points assuming the UK has voted to stay in the EU and US economic data remains satisfactory, not least in terms of rising wages and inflation. 

Meanwhile, investors in US 10-year Treasuries have had such a favourable run for many years that they may be underestimating Janet Yellen and colleagues’ potential to raise the Federal Funds Rate closer to 2% over the next year to eighteen months.  Today’s upward dynamic on the US 10-year Yield daily chart could be a shot across the bows.  Also, keep an eye on the Merrill Lynch Treasury 10-Yr Total Return Index.  While a lagging indicator and only updated through 16^th May, it currently remains in a mostly consistent uptrend.  However, watch for an eventual pullback which exceeds the last three largest reactions on this chart, currently taking it below at least 2000.  That bigger pullback will most likely confirm an important peak.