GDP growth ticks lower but wage gains pick up speed: Market takes possibility of four interest increases from Fed in 2018 more seriously

U.S. GDP grew at an annualized rate of 2.3% in the first quarter, the Bureau of Economic Analysis announced before the financial markets opened for trading this morning in New York. Economists surveyed by Briefing.com had expected growth of 2.1%. In the fourth quarter of 2017, the U.S. economy had grown at an annualized rate of 2.9%.
 
But the rate of growth for the U.S. economy was overshadowed by other data in this morning’s report showing a significant increase in wages and inflation. Compensation costs for workers in private industry increased by 2.7% for the 12 months ended in March 2018. That’s up from a 12-month rate of increase of 2.3% for the 12 months ended in March 2017.
 
In the first quarter of 2018 the core Personal Consumption Expenditures index, the Federal Reserves’s preferred measure of inflation, climbed by a 2.5% annualized rate. (The most recent monthly PCE numbers will be released on Monday.) That puts inflation, by this measure, well above the Fed’s 2% target.
 
And that leads to the conclusion that the Federal Reserve is indeed more likely to raise interest rates four times in 2018–with the second rate increase in 2018 coming in June–than the three times expected by the Wall Street consensus.
The CME Fed Watch tool, which calculates the odds of a rate move by the Federal Reserve by looking at prices in the Fed Funds Futures market, sees a tiny 6.7% chance of the Fed raising interest rates at next week’s May 2 meeting. (The Fed doesn’t like to raise rates at meetings without scheduled press conferences and nothing is scheduled for May 2.) Odds of an interest rate increase, however, are now 100% for the Fed’s June 13 meeting. Odds for an additional interest rate increase beyond the June move at the August 1 meeting are again a low 10.5% for the same reason as in May. But odds for an additional interest rate increase at the September 26 meeting at now at 77.1%. The odds for a fourth increase at the 11 December meeting have now climbed to 47.1%. (My rule of thumb is that odds of anything better than 65% guarantee either an interest rate increase at that meeting or a strong, visible effort to talk the market out of its convictions.)

As of 1:30 p.m. today yield on the benchmark 10-year Treasury was down two basis points on the day to 2.96%. The yield on the 2-year Treasury note, which is more sensitive to the direction of short-term interest rates, was 2.48%. The yield on the 2-year Treasury is p 22 basis points in the last month and 122 basis points in the last 12 months. (100 basis points equal one percentage point.)