Fed looking for only 'some' more improvement

The recent U.S. dollar strength is largely a function of Fed policy expectations. Liftoff had previously been pushed out into 2016 due to the U.S. economy stumbling at the start of the year. But, improving economic indicators since have increasingly boosted the odds of at least one rate hike during 2015, putting the market more in line with the prevailing FOMC stance.

U.S. economic growth was revised up to 0.6% in Q1, before accelerating to 2.3% in Q2. While the 1.5% gain during the first half is not red-hot, it is respectable in light of the headwinds faced by the U.S. economy.

These headwinds should abate and be increasingly offset by strength in consumption and housing, with growth expected to accelerate in the second half of the year. 

The improving economy should provide the Fed with enough confidence to begin raising rates this year, with the FOMC now looking for only “some” additional improvement in the labor market before liftoff. The addition of the “some” qualifier indicates that the Fed is becoming increasingly comfortable with economic progress to pull the rate lever. While this morning’s Employment Cost Index fell shy of expectations, suggesting that wage pressures remain limited, core inflation appears to be heating up according to the Fed’s favored PCE deflator measure. 

"Ultimately, the Fed decisions will be data dependent, with two monthly employment reports being top of mind. If the labor market continues to improve and core inflation tracks higher, we believe that an earlier start to a more gradual tightening cycle, suggested as a 'prudent approach' by Chair Yellen, should be expected. Accordingly, September remains a very likely timeframe for liftoff in our view," said Michael Dolega, Senior Economist at TD Economics.