The Federal Open Market Committee will give economists and investors an opportunity this week to parse the minutes of its June 12-13 meeting for signals of its agenda.

"I expect market expectations of a fourth rate increase to rise," said Doug Duncan, chief economist at Fannie Mae. "I also expect the 10 year to strengthen a bit. I think [Federal Reserve Board Chair Jerome Powell's] press conference was the second step of three to asserting his leadership. In it he signaled that he intends to be the only voice that matters, that he expects to communicate in a language both the markets and the public use, and that he expects to return monetary policy toward a role more realistic given its blunt tools."

Market participants will be curious to see if the panel discussed "what the long term real rate is or about what the neutral rate is." If so, Duncan said, "that would be enlightening." They will also try to gauge if there is "a broader consensus … that the economy is indeed as strong as suggested by Powell."

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The market is also concerned about the possibility of an inverted yield curve, though some observers said worries about that recession indicator may be premature.

"First, a true inversion is short-term rates above long-term rates," said John Donaldson, director of fixed income at Haverford Trust. "The 2-10 year spread is the focus of the markets, yet not the best indicator. In our opinion, you would need to get 3-month rates above 10-year rates for a true inversion. We are a long way from that."

Also, with the Treasury Department using T-bills more to fund the deficit, "That shift in financing calls into question the validity of the yield curve as an economic predictor."

What's more, he said, the minutes are unlikely to provide any debate on the topic, since it's more a budget question than monetary policy.

Still, the FOMC will need to determine when to stop raising rates.

"The difficult task in front of the FOMC is to judge how much to tighten for what the economy will look like once the near-term benefits of stimulus start to taper off," Donaldson said. "The risk is that they keep tightening just as the economy would slow down and hence help accelerate that slowdown. The markets will look for clues on what the FOMC sees as short-term and what it sees as longer-term.

"With regard to tightening, the more important question is whether the FOMC is so committed to tightening that it will do so no matter what else is happening," Donaldson said. "One conundrum in front of them is that they have been tightening since December 2015 and yet financial conditions are actually modestly easier today than then."

With inflation at the Fed's 2% target, "the hawks on the FOMC have an additional data point to argue in favor of two more hikes July to December," said Stifel Chief Economist Lindsey Piegza. "Of course, an overzealous Fed also increases the risk of raising rates too fast and potentially inverting the curve by the end of 2018, historically an indication of an ensuing recession 12-18 months later."

Indeed, the question of what is neutral still needs to be answered.

"Atlanta Fed President Rafael Bostic recently gave his range for neutral fed funds as 2.75-3.00%," BNP Paribas economist Andrew Schneider wrote in a report Thursday. "With fed funds currently at 1.75-2.00%, this implies fed funds will be at neutral levels with just another two hikes. Once rates reach neutral levels, we think the Fed will find it difficult to press on if activity data begins to wobble; tighter financial conditions and pressure from the White House would make doing so even more difficult. Thus, we think the Fed will likely be nimble in pausing its hiking cycle in such a scenario. We see the Fed getting in another three hikes, taking fed funds to 2.50-2.75% by March, before it steps off the gas and pauses its hiking cycle."

While the Fed's Summary of Economic Projections in June increased the expected number of rate hikes for the remainder of the year to two from one, the markets are not necessarily buying in. Brian Rehling, co-head of global fixed income strategy at Wells Fargo Investment Institute, said "the outlook for 1 or 2 rate hikes the rest of this year is uncertain," and while the minutes won't explicitly state "any meaningful new revelations," participants will seek clues in "the nuance and wording … and what exactly the Fed is most focused on in making that determination."

Anyone looking for surprises in the minutes will be disappointed, according to Paul J. McCarthy, III, president of Kisco Capital, LLC. "The last time the Fed surprised the bond market was in the Greenspan era. Most moves have been telegraphed since that time."

But, he noted, "there will be focus on any language regarding the reduction in the size of their balance sheet towards the end of this year. That is more important than the number of rate increases in 2018. The Fed's balance sheet has provided much liquidity to the capital markets and there may be concern of what happens when the punchbowl is removed."

Participants will also look at any discussion of the yield curve. "If the 2/10s spread goes negative (inverts) then bond market traders would be warning of a Fed induced recession sometime in 2019.

If the minutes show concern about dollar strength, it could suggest slightly less hawkish monetary policy, and lower bond yields, according to Wilmington Trust Economist Rhea Thomas.

Talk of the unemployment rate could also give clues to future policy, as a "pickup in wages would likely be taken as support for hawkish monetary policy."

As for trade jitters, "Any signs of a willingness to be more accommodative in the face of a rise in trade concerns would likely be deemed as dovish, and would potentially weigh on bond yields," Thomas said.

Gary Siegel

Gary Siegel

Gary Siegel has been at The Bond Buyer since 1989, currently covering economic indicators and the Federal Reserve system.