As Yellen hints at rate hikes, PCE and NFP to influence conviction

Last Friday's price action was probably akin to the type of volatility one see's during FOMC meetings. Indeed for all the hype surrounding Fed Chair's speech, Janet Yellen (thankfully) did not disappoint. While the markets were bracing for a hawkish talk from Yellen, there was also the possibility that Yellen could take a more diplomatic approach and maintain neutral ground. But that wasn't the case.

A closer look at Yellen's speech at Jackson Hole, a full text which actually shows just a few lines in her speech which sent the markets abuzz. Yellen said, “Looking ahead, the FOMC expects moderate growth in the real gross domestic product (GDP), additional strengthening in the labor market, and inflation rising to 2 percent over the next few years. Based on this economic outlook, the FOMC continues to anticipate that gradual increases in the federal fund's rate will be appropriate over time to achieve and sustain employment and inflation near our statutory objectives. Indeed, in light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal fund's rate has strengthened in recent months. Of course, our decisions always depend on the degree to which incoming data continues to confirm the Committee's outlook.”

While the markets initially plunged on the statement, there was a strong recovery in the following minutes in what could be at best a knee-jerk reaction. However, after an hour or two, the markets soon settled with the US dollar saw strengthening gradually as momentum picked up. EURUSD lost 0.77% on the day.

Yellen offers ‘some’ clarity

Yellen’s remarks gave support to comments from several other central bank officials over the past two weeks who also argued the economy was improving, and another rate hike is appropriate. In effect, this means there's a decent but not great chance the Fed could raise rates at its next meeting, in September. While a few weeks ago it was William Dudley, Stanley Fischer, John Williams, last week saw Kansas City Fed, Esther George maintain her hawkish views.

The FOMC’s next meeting is scheduled for September 20 – 21 which will include staff economic projections as well as a press conference chaired by Janet Yellen.

By Friday’s close, the CME Futures Fed Watch tool showed the implied probability of a 25 basis points rate hike in September rising to 33% from 21% previously. It was not so long ago that the September rate hike probability was at a mere 9%.

PCE and Jobs data on tap

This week will see Personal Consumption Expenditure data coming out on Monday. Being the Fed’s preferred gauge of consumer inflation, there is no doubt that the markets will be cued on to the event. Economists expect the core PCE price index to slip a point to 1.50% in July on a year over year basis, down from 1.60% in June, while the headline PCE price index is also expected to slide a notch lower to 0.80% compared to 0.90% in June. In the event of a positive beat on estimates, the markets could see the rate hike prospects turn higher, so long as the data does not fall below estimates which could dent sentiment. With the core PCE sitting near 1.60% as of June, it remains within sight of the 2.0% mandated target rate.

Following the PCE data on Monday, the baton will be passed on to Friday’s nonfarm payrolls report which is likely to be crucial as a disappointment could see the markets make a significant shift in their rate hike expectations and potentially offset any gains made on Monday’s PCE report. Estimates point to the US economy adding 186k jobs for August after payrolls increased 255k in July. The US unemployment rate is expected to slide back to 4.80% for August. Any revisions to past data and the August data itself will be a big game changer.

Despite the initial euphoria following Yellen’s statement on Friday the ‘timing’ on the Fed rate hike still remains questionable. This week, we could see the economic data address just these questions. At the lower end of the scale, as long as PCE and NFP don't disappoint, September could very well see the Fed move rates higher.