Hawkish Fed Chatter And Another Slide In Base Money Supply

A second interest rate hike may be near, advised New York Fed President Bill Dudley on Thursday. “If I’m convinced that my own forecast is on track, then I think a tightening in the summer, the June-July time frame, is a reasonable expectation.” The release of Fed minutes from the last policy meeting fall in line with that thinking. So, too, does the April update on real (inflation-adjusted) base money supply (M0), which contracted in year-over-year terms in April, marking the third decline in the past four months.

The St. Louis Adjusted Monetary Base (deflated by the consumer price index) fell 5.4% last month vs. the year earlier level, a slightly bigger dip after the annual decline through March. The current year-over-year slide marks the third time that the Federal Reserve has embraced a tightening cycle since the last recession ended. In the previous two rounds of squeezing policy, based on M0 annual changes, the central bank relented and resumed a bias for stimulus. Is this time different?

Dudley’s latest comments certainly leave room for expecting that monetary policy will continue to tighten. As Reuters reports,

“June is definitely a live meeting depending on how the data evolves,” Dudley said, adding that he was “quite pleased” to see the market has priced in higher chances of a June rate hike this week.

The effective Fed funds rate (EFF) is stable, holding at a level that’s prevailed for much of 2016 to date. But that doesn’t mean much. EFF offered no hint of a rate hike last December, ahead of the Fed’s announcement on the 16th of that month to increase its policy rate for the first time in nearly a decade to a 0.25%-to-0.50% range, which still stands. The EFF eventually surged to reflect the shift, but on Dec. 16th… after the fact (EFF data is released with a lag).

Market sentiment, however, has abruptly changed in line with Dudley’s comments. Fed funds futures (based on CME data for May 19) are now pricing in a 70% probability of a rate hike at next month’s FOMC meeting—a dramatic shift from the recent past, when a June squeeze was widely dismissed as unlikely.