Some Inconvenient Facts for the Fed -- Heard on the Street

By Justin Lahart Features Dow Jones Newswires

The facts have changed. Will the Federal Reserve change its mind?

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There is no such thing as a sure thing, but a Fed rate increase next week is close. Officials at the central bank have made it clear they plan to lift their target range on overnight rates, and futures markets are putting the odds at better than 90% that a move will be made at the meeting that concludes June 14.

But when Fed policymakers look beyond next week, they will have to consider a few inconvenient facts. First, even though unemployment is low, wage growth remains weak, and inflation has cooled. Second, the economy remains stuck in a slow-growth rut. And third, the chances of near-term tax cuts and fiscal stimulus, which could provide a meaningful economic boost, have fallen.

That is the message not just from the data and the headlines, but from the market. The yield on the 10-year Treasury note on Tuesday slipped to its lowest in more than a half-year -- an indication that bond investors have downgraded their growth and inflation expectations.

None of these developments are likely to prevent a rate increase next week, but they could prompt the Fed to rethink its projected rate increases through next year and its plan to begin winding down its balance sheet.

At the outset of the year it seemed as if the economy might be shifting into higher gear, with the election of President Donald Trump bringing about a burst of optimism at many businesses. But the good vibes didn't translate into better growth. Gross domestic product increased at just a 1.2% annual rate in the first quarter. Most economists reckon it will rebound to about 3% rate in the current quarter.

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The underlying trend remains around 2%, about the growth rate the economy has shown over the past several years. If policymakers at the Fed thought growth was going to run meaningfully faster this year, they shouldn't think it anymore.

There is, of course, the possibility that there will be tax cuts and a stimulus plan. But with no concrete proposals in place, and with the White House snarled by distractions, the chances seem slimmer than they did at the start of the year.

For the Fed that matters: Minutes from its December rate-setting meeting indicate Fed staff economists incorporated an assumption of more expansionary government policy in their forecasts, as did half the central bank's policy makers. If they have come to think the economy isn't about to get a shot in the arm, they should at least reconsider their plans.

Finally, early signs that wages and inflation were heating up have evaporated. Last week's job report showed that average hourly earnings were up 2.5% on the year last month, versus a gain of 2.9% in December. Excluding food and energy, the Fed's preferred measure of inflation showed consumer prices were up 1.5% from a year earlier in April, marking the smallest gain in over a year.

The danger for investors is that while the Fed has exhibited a tendency to change course when presented with softer data, it has also been dogged about sticking to its plans until it caves. Markets could be in for an interesting summer.

Write to Justin Lahart at justin.lahart@wsj.com

(END) Dow Jones Newswires

June 06, 2017 14:20 ET (18:20 GMT)