2 things everybody missed in the Fed’s latest release – Yahoo Finance

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Investors squealed when the Federal Reserve suggested recently that it might raise interest rates in June, after all. They shouldn’t have.

The minutes from the latest meeting of the Fed’s policy-making committee contained some unusually aggressive language (for the Fed),suggesting investors have become too complacent about the Fed maintaining super-easy monetary policy. Here are a couple of the key phrases that sent stocks reeling in the aftermath of the latest announcement:

Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June…. Market participants may not have properly assessed the likelihood of an increase in the target range at the June meeting.

Prior to this release, prediction markets had judged there to be a 19% likelihood the Fed would raise rates in June. That jumped to 34% once the minutes were out, which pushed down stocks, since higher rates generally impact corporate profits negatively.

But hold on a minute. The Fed’s meeting at which it discussed labor market conditions and other factors was held on April 26 and 27. Since then, the labor market has weakened or at best, flatlined. The employment report for April, which came out on May 6, showed that employers created only 160,000 during the month, a sharp drop from the 243,000 new jobs averaged during the prior six months. And initial claims for unemployment insurance have been ticking upward the last few weeks, running about 10% higher in May than in April.

The weaker May figures could be an anomaly that ends up getting revised upward as the data firms up. Or, it could indicate a slowdown in hiring, which would actually fit with weaker corporate profits and other signs of a stagnating economy. Since this is happening after the Fed meeting we’re all analyzing now, it could essentially render the bullish sentiment at that meeting irrelevant. And the Fed emphasizes that instead of being programmed to raise rates on such-and-such a date, it is “data-dependent,” meaning it will only hike when the numbers provide a convincing case to do so. At the moment, they don’t.

The second overlooked factor in the Fed’s crystal ball is China. Fed Chair Janet Yellen is reluctant to say this, because the Fed is supposed to focus solely on inflation and unemployment in the United States, but it can’t ignore financial conditions in China, which undoubtedly have some sway over Fed policy. “Unwinding the greatest monetary policy experiment in US history is being hampered by the Chinese,” David Zervos, chief market strategist at Jefferies,wrote in a recent note to clients.

The problem is that the Fed is trying to raise rates and tighten monetary policy while China is trying to keep its policy loose and perhaps ease even further. Rising rates in the United States portend a stronger dollar, and by extension a weaker Chinese currency (the yuan) vis-a-vis the dollar. Since China’s central bank has its own target for the value of the yuan, Fed tightening could push the yuan outside its target range and undermine China’s own monetary stimulus. With concerns already mounting about debt bubbles and other problems in the Chinese economy, the diverging policies of the two central banks could cause more turmoil instead of the stability central banks are supposed to encourage.

Many investors believe these diverging policies already contributed to manic moves in the Chinese stock markets last August and early this year, which in turn forced global markets down. So even if an improving U.S. economy supported the case for a rate hike, the risk of unleashing more volatility in China could mount a stronger case against tightening.

Still, with the unemployment rate at 5% and inflation very low, the Fed seems like it must raise rates a bit more, relatively soon, or risk even more criticism that it has grown captive to outside interests. After the mid-June meeting, Fed policymakers gather in late July, late September, early November and late December. The Fed seems unlikely to do anything at the two meetings that will take place during the home stretch of the fall elections. So if there’s no rate hike in June, it will likely come either in July or December. The real message for markets, rather than refocusing on June, may be July or bust.

Rick Newman’s latest book is Liberty for All: A Manifesto for Reclaiming Financial and Political Freedom. Follow him on Twitter: @rickjnewman.

2 things everybody missed in the Fed’s latest release – Yahoo Finance}