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Keep a sharp eye on the Fed's new meeting minutes

Fed Hikes Interest Rates

Wall Street is looking ahead to Wednesday's release of the minutes of the Federal Reserve's most recent rate-setting meeting. Investors will scour them for clues as to the pace and timing of possible interest rate hikes through the end of the year. The Fed has raised rates by three-quarters of a point since it started its tightening cycle in December 2015.

That pace of increases has accelerated lately as confidence and stock prices have soared since Election Day. Currently, the futures market is pricing in a 78.5 percent chance of another quarter-point hike on June 14, up from 50.7 percent odds a month ago. Through year-end, the odds are about 50-50 of another hike after that.

But this outlook is far from unanimous, given the reappearance of stock market volatility last week (on political headlines and the risk to President Donald Trump's agenda), an underwhelming first-quarter GDP report and ongoing softness in the economic data (the Citigroup Economic Surprise Index is at a level not seen since early 2015).

Add to this some recent easing in the inflation data as well. As noted by Goldman Sachs economist Jan Hatzius in a recent note to clients, the latest Consumer Price Index inflation report fell to a 1.89 percent annual rate in April from 2.22 percent in February. 

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While a concern, Hatzius believes ongoing labor market strength will override the inflation data in the minds of Fed policymakers. The unemployment rate fell to 4.4 percent last month, 0.1 percent bellows the Fed's own year-end forecast.

Alternative measures of labor market strength remain robust as well, from the employment-to-population ratio to continuing unemployment claims and payroll growth.

While Hatzius had been expecting a third 2017 rate hike in September, he has downgraded those expectations slightly in favor of an outside possibility the Fed will instead announce the beginning of a "runoff" of its balance sheet -- which expanded from around $800 billion before the last recession to some $4 trillion now, thanks to multiple asset purchases as part of its stimulus programs.

The Wall Street consensus was for no balance sheet action until December because it represented a "new" and thus potentially more potent form of policy tightening. Hatzius' analysis suggests otherwise, however, and when combined with comments from Fed officials such as Chicago Fed President Charles Evans (who casually said "July or September, or something like that" about timing), this is something investors should definitely put on their radar.

Especially because it's likely that the Trump White House and Congress will be locking horns over fiscal issues during the September time frame. Thus, another outright rate hike might magnify what's likely to be a nervous market environment.

Either way, Wednesday's meeting minutes will provide additional clues about what to expect. This will be especially important since Bank of America Merrill Lynch believes the markets could be warning the Fed of a policy mistake given the way the odds of additional rate hikes have been falling even as odds of a June hike have been rising.