FOMC Minutes: What to Expect

What to expect from the FOMC minutes tomorrow.

Bond yields have been fluctuating wildly over the past weeks, with iShares Barclays 20+ Yr Treas.Bond (ETF) (NYSEARCA:TLT) , the ETF that tracks the 20 year Treasury, collapsing by 9% since May 17.  At the same time, the 2x short ETF, ProShares UltraShort Lehman 20+ Yr(ETF) (NYSEARCA:TBT), increased by about 20% over the same time period.  To put it mildly, bond investors are telling us that they expect higher interest rates on the almost immediate horizon, and although the FOMC minutes will reflect a meeting that came before the recent employment data release, I have come to expect the FOMC to have access to preliminary data and therefore it may have already been built into the meeting to some degree.

However, without debating that facet, we should consider the probable indicators these FOMC minutes will provide.  We can be sure they did not want to raise rates last time, at least reasonably sure, and we can be sure (reasonably) that they continue to look for an opportunity to raise interest rates.

We know the data that they are watching too, inflation and employment.

They want 2% inflation and they want full employment, and they consider full employment and hourly wage increases to be impactful to CPI.

Although the recent employment report was solid, the previous employment report was awful, and that will almost surely be recognized in the minutes, but again the FOMC tends to be privy to preliminary data so there is a very good chance they were aware that the employment number would bounce back.

On the same note, they are also probably privy today to what the CPI result on Friday will be before it becomes public, and that is expected to be at or near 0%.

Without inflation the FOMC has plenty of reason to wait.

The bounce back in the labor market will probably put some members of the FOMC in the camp that suggests rates should increase almost immediately, but the doves have an argument too.  The dovish members can safely say that without inflation they cannot yet raise interest rates.

What we can expect from the minutes is a dialogue that debates higher rates with the support of a better employment situation, with Q1 being discounted, and a counter argument about low inflation and the need for higher inflation before rates go up as well.

The interesting part of this conversation is that higher interest rates would make PPI increase most likely, which in turn could create pricing pressure on the consumer side.  The question is can the current market handle that, and that is where the hourly wage indicator comes into play.

As it stands now wage increases are near 0% while inflation is near 0% suggesting that the market would not be able to handle inflation induced by higher interest rates at this time.  For example, if CPI inflation was pressing 2% but wage increases were 0% that would not be sustainable.

The result is that there are two sides to this debate and this should be reflected in the FOMC minutes.

  1. The employment data suggests raising rates.
  2. The inflation data tells us to keep rates as they are for now.

I expect to hear this from the minutes tomorrow.