How Long will the Fed Keep Interest Rates low?

<p>The minutes of the Fed meeting in June showed that officials want to give more certainty to investors about the path of interest rates. More specifically, the Central Bank is exploring the possibility of “tying” low interest rates to some goal, like achieving certain macroeconomic goal. For example, keep rates at current level until unemployment drops to 4%. This idea is not new and is similar to a pledge to keep rates low until inflation reaches some target, but we can say now that officials want to make a stronger statement.</p>
<p>For the US dollar, such Fed stance is clearly a downside risk, since by tying the policy to a macroeconomic event, the Fed loses opportunity to respond flexibly to the “unforeseen” accelerated recovery of economic activity (as it usually does). Of course, we have to take into account monetary policy of other central banks. Dollar decline will be more pronounced if other central banks choose to remain flexible and less categorical (i.e. less dovish) in their guidance for markets.</p>
<p>US crude oil stocks declined 7.1 million barrels, beating forecast of 0.71 million barrels, showed the latest report from the EIA. As oil prices continue to drift into profitable zone for US oil producers, they have more incentive to increase output, hence reduction of stocks could be achieved due to the outflow of oil from the inventories exceeding inflow. In other words, oil demand in the United States can be recovering faster than production, which is essential sign of expansion. Oil prices advanced by 1.5% on Thursday thanks to the positive EIA update and are likely to extend gains, pricing in expectations of more signals that the US economic recovery is gaining traction.</p>
<p>Sweeping reaction by the European government to prevent spillover from falling incomes on consumption seem to have been crowned with success: retail sales in Germany rose 3.8% in May against the forecast of -3.5%. Government countermeasures to retain jobs apparently were also successful – the number of unemployed increased by 69K in June, beating forecast of 120K.</p>
<p>Unexpected pickup activity of the manufacturing sector in the United States prompts us to revise outlook of recovery in manufacturing sector as well.  ISM production PMI rose to 52.6 points in June, Markit PMI – to 49.8 points. Both indicators beat forecasts.</p>
<p>There was a little disappointment in the ADP jobs report, which estimated gain in jobs at 2.369 million with a forecast of 3 million new jobs. Government schemes to avoid layoffs in the form of cheap liquidity sources like PPP loans which helped to offset declining sales volume on demand for labor contributed significantly to the boost in employment in May.</p>
<p>All states in the US continued phasing out lockdowns in June, so it’s reasonable to expect that while this process continues, the number of jobs will increase. Given the available information about the quarantine removal process, even big surprise in jobs count may be discounted by investors, although markets may not be ready for a weak report. Payrolls are expected to show 3.5M gain in June.</p>
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