Column: About that June or July rate hike - James Saft

Column: About that June or July rate hike - James Saft

By James Saft

(Reuters) - Here is a short recipe: Take a weakening service sector, contracting corporate profits and capital expenditure, add a Federal Reserve rate hike and stand well back.

The resulting dish may not be best served cold, but the economy in which we eat it definitely would be cooling.

Of course, we probably won't have to eat this particular variety of Federal Reserve pie because the Fed will delay the June or July rate hike members have been signaling. 

"Depending on the incoming data and the evolving risks, another rate increase may be appropriate fairly soon," Federal Reserve Governor Jerome Powell said on Thursday, becoming the latest to give the impression that a summer increase is likely.

He tempered his remarks by noting concern over Britain's EU exit referendum in June and added that the risks of waiting were "not that great."

Durable goods data released on Thursday, while coming with a fantastic headline figure courtesy of a spike in airline orders, showed some definite signs of underlying weakness. Company capital spending, a good gauge not only of current but future activity, is slumping, down 0.8 percentage point from April to March and 4.1 percent from a year ago.

The capital expenditure data comes closely after the Markit survey of service sector purchasing managers found them at their least optimistic in six-and-a-half years - in other words, since just after the last recession. Some managers cited uncertainty over the presidential election, a factor that will only grow in impact as we approach November. The overall reading is still expansionary but job creation in services - which comprise two- thirds of output - was slowing, according to the survey.

Total business inventories-to-sales, a measure of both demand and corporate health, has risen in the past year, taking it to a level not seen since spring of 2009, the tail-end of the last recession. All of this is before we consider external risks, from the aforementioned Brexit vote to China’s ongoing and ragged attempts to both boost growth and transition its economy toward consumption.

The Fed doubtless earnestly wants to hike, if only to get some room between itself and the zero bound before a genuine downturn. But now does not seem to be a good time.


David Levy, economist at the Levy Forecasting Center, points out that not only are corporate profits in retreat in major and emerging economies, but world trade has also slowed. "Global economies have suffered the kinds of earnings declines that normally induce business retrenchments that begin the vicious cycle of recessions," Levy wrote in a note to clients.

"Declining profits have become ubiquitous across countries and sectors. Moreover, global trade has been contracting, both in unit volume and in nominal terms. Contracting trade and falling profits are typically recessionary phenomena."

To be sure, while things have a distinctly late-cycle feel about them, it is not as if there are strong signs that we definitely are moving toward a near-term recession. Employment remains strong, and while it often does until just before a recession, it is far more often a sign that things are going well. The build in inventories too, while not a good sign for profitability or demand, is hardly flashing distress. It is when inventories begin to be aggressively liquidated that we are truly in trouble, and housing is not too bad at all.

Much of what we are seeing is in line with a low-growth year, with an annual increase in output of 1 to 2 percent. Not what we typically associate with a tightening cycle.

It is easy to see why Fed officials would like to be able to raise rates in June or July. If not in the next two meetings, then they, and we, will be staring down the barrel of the presidential election, with only two more meetings before the big day. It isn't that the Fed is under an obligation to sit out an election, it is that this particular election, with Donald Trump as one candidate, has a exceptionally wide range of possible government policy outcomes.

How do you set monetary policy in anticipation of a possible trade war? Gingerly.

Futures markets are placing a 54 percent chance of an increase to 0.75 percent or 1.00 percent by July. But if the next few pieces of data are anything like the services PMI or durable goods numbers, the Fed will find it difficult to hike any time soon.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at and find more columns at

(Editing by Dan Grebler)