Rate-sensitive sectors will “take a hit” leading up to Fed hike

In early November, the U.S. Federal Reserve held off on a rate hike. But the meeting minutes reveal the Fed is positive on where the economy is headed.

In the minutes, the Fed points to solid GDP growth, encouraging labour conditions and a faster pace for consumer price inflation growth–all signs that the U.S. economy is improving. Further, say the minutes, “domestic financial markets were relatively calm” between September and November.

One remaining sore spot is the sensitivity of foreign equity indexes to political strife. The minutes say global markets “broadly increased over the intermeeting period. Nonetheless, foreign financial markets were sensitive to news about upcoming negotiations between the United Kingdom and the European Union over [Brexit], as well as to ongoing developments in the European banking sector.”

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Some Fed members are also concerned about what’s driving the rise in U.S. labour force participation. The minutes say, “A few [FOMC members] noted that the increase [in participation] had largely reflected a [drop] in the flow of individuals leaving the workforce rather than an increase of new entrants […] Participants expressed uncertainty about how long the participation rate could be expected to continue rising.”

Still, two FOMC members–Esther L. George and Loretta J. Mester–voted to raise the target range for the federal funds rate. Their view, as expressed by Mester, is that “the economy was essentially at full employment in terms of what can be achieved through monetary policy,” and that labour market conditions are likely to tighten further.

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Since that meeting…

The biggest development has been president-elect Donald’s Trump’s U.S. election win. Major markets have risen across North America so far, and some of the main topics have been the outlooks for inflation, global currencies and bonds under his leadership.

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Looking forward, most FOMC members wanted to raise rates soon, as of November 2nd. The minutes say, “It could well become appropriate to raise the target range for the federal funds rate relatively soon. […] Some participants noted that recent Committee communications were consistent with an increase in the target range for the federal funds rate in the near term, or argued that to preserve credibility, such an increase should occur at the next meeting.”

And that hasn’t changed: in recent prepared testimony to a congressional committee, Fed Chair Janet Yellen said the case for a rate hike has strengthened. Indeed, CME Group’s FedWatch Tool shows markets are calling for a 93.5% chance of rate hike.

Royce Mendes, director at CIBC World Markets, says in a research note, “The Fed’s most recent statement was light on changes, but the markets heard the message loud and clear. The minutes of the meeting only confirm that the Fed is ready to tighten policy in December, with most members seeing a rate hike as being appropriate ‘relatively soon.'”

Still, it’s likely the pace of tightening will be gradual, says CIBC. “Several officials judged there is still appreciable slack in the labour market, in direct contrast to those who believe that further gains will push the economy through full employment. Moreover, some Fed officials remain wary of tightening too early, with monetary policy so close to the lower bound.”

Senior economist James Marple of TD Economics says the minutes have a “dated” feel. But, he adds, “A key element to listen for from the Federal Reserve is how [the Fed] will respond to the change in financial conditions since the election. While the sell-off in bonds and rally in the U.S. dollar is due to increased expectations for fiscal stimulus, the timing and scope of these actions is still highly uncertain.”

Between now and December, he notes, “interest- and exchange-rate sensitive sectors of the economy like housing and trade will take a hit, suggesting some downside risk to economic growth.”

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