Fed falling further behind the curve

While we didn’t think that the more modest 160,000 increase in payroll employment in April necessarily ruled out the possibility of a June rate hike by the Fed, the increasing probability that employment will be even weaker in May probably does. Under those circumstances, we can’t see the Fed raising interest rates next month, even though financial conditions have improved markedly and most other evidence suggests that second-quarter GDP growth accelerated to an above-potential 2.5% annualised. We now expect the Fed to raise interest rates only twice this year, probably in September and December, taking the fed funds rate to between 0.75% and 1.00% by year-end. Nevertheless, we still expect rising inflation to prompt the Fed to raise rates more aggressively next year, with the fed funds rate reaching between 2.25% and 2.50% by end-2017.