All the rhetoric in recent weeks from Fed policymakers about the outlook for rates will be distilled in the FOMC’s collective forecasts in the Summary of Economic Projections (SEP). I expect that markets are going to be disappointed when they see how little the FOMC has moved in its fed funds rates projections from those published in March.
The FOMC next meets on Tuesday and Wednesday, June 18 and 19. This is one of the four meetings in the year at which the FOMC formally updates its economic projections for the remainder of the year, the next two years, and the longer-run. The SEP will be released along with the post-meeting statement at 14:00 ET on Wednesday, June 19.
In the December 2018 SEP, the FOMC made a downgrade to their expectations for GDP in 2019, anticipated unemployment rates to remain low and steady, and inflation to run a touch softer overall.
In the March 2018 SEP, the FOMC forecasts again downgraded the pace of growth for 2019, upped the anticipated unemployment rate – albeit to a continued substantive undershoot of the longer-run forecast – and looked for another downtick in overall inflation.
The March forecast temperature was taken with several unknowns. Economic data reports were still playing catch-up after the partial federal government shutdown. However, at the time of the meeting of March 19-20, the FOMC had in hand data that put first quarter growth at a strong level and the labor market humming along without apparent fundamental damage from slower economic conditions in the fourth quarter or lasting impact from the government shutdown. There was some evidence that inflation and inflation expectations was down, but with enough reasons to explain it as transitory from idiosyncratic factors. The outcome of trade negotiations with China was unresolved. Several geopolitical issues like the shape of Brexit were also yet to be clear.
Many of these factors are remain present and without answers as to how they will ultimately fall out. If the risks to the economy remain heightened and market stresses increased, the economic data does not suggest that underlying conditions are anything other than expansionary.
In terms of the Fed’s dual mandate:
- The labor market is showing plenty of flexed muscle. Conditions are such that those less employable in a normal market are finding reason to search for employment and finding it. Those who are more skilled are switching jobs at record numbers and employers are offering higher wages and/or benefits to capture them or retain present workforces. The 3.6% unemployment rate of April and May is exceptional in the historical context and for an expansion in its 120th month. Some slowdown in hiring after the blistering pace of 2018 is to be expected and should not be alarming. The up 75,000 of May has to be balanced with the up 224,000 in April and the fact that even in a healthy expansion there is a weak report now and again. Indeed, the six-month moving average for May was up 175,000 was quite similar to the 172,000 six-month moving average in January 2018 and not dissimilar to levels prevailing over 2017. A few month-to-month swings should not obscure that businesses are hiring at a persistent pace well above that able to absorb new workers entering the labor market and bring in some from the sidelines.
- The wobble in inflation and inflation expectations in the first months of 2019 has now given way to somewhat firmer readings. The noticeable decline for the year-over-year readings in the PCE deflator in the first quarter were not mirrored in other measures of inflation, giving substance to Chair Powell’s assertion that the numbers could be influenced by narrow transitory factors. The PCE deflator is the Fed’s benchmark for its 2% inflation objective, but it is not the only inflation data that policymakers pay attention to. As for worries about the credibility of the Fed’s inflation target compared to inflation expectations, recent increases in measures of consumer and business anticipation of inflation have firmed as well. Risks to inflation are to the upside for energy due to geopolitical events, and commodities may see renewed upward pressure if higher tariffs on goods from China arrive.
The FOMC is not ignoring market expectations of a rate hike at the July 30-31 meeting. However, the Committee is not going to set policy based on what the market wants. Volatility in stocks and plunging Treasury yields are not in themselves persuasive that an economic downturn is on the way. The brief inversions of the 3-month/10-year note yields in recent weeks may be unsettling. But it is the 2-year/10-year curves that a few Fed policymakers have cited in remarks and these are less chilling for the outlook. Indeed, the drop in 10-year Treasury yields have provided a source of stimulus for a sector of the economy that languished in the second half of 2018 – residential real estate. The boost from homebuying and refinancing – which will help business in services and retail – could be enough to lift GDP in late part of the first quarter provide upward momentum for consumption in the second. In any case, market jitters alone will not force the Fed’s hand when it comes to a rate cut.
As I have said before, policymakers may be more willing to provide an insurance cut in rates, that does not mean they intend to do so unless and until the economic data signals one is genuinely needed to ensure a downturn does not emerge. Interpreting recent comments as any sort of pledge or promise of a future rate cut is a mistake. Beyond a commitment to achieving the dual mandate based on the best available data and information, it would take stronger and clearer language than I have read so far to suggest a cut in in the works. Policymakers are acknowledging heightened risks, not present realities. Growth held around 2% over most of the 120 months of unspectacular period of expansion that still resulted in a robust labor market and allowed the Fed to gently normalize monetary policy. The FOMC consensus is not going to want to sacrifice any of those steps unless necessary.
The June 18-19 meeting is not expected to see a change in the fed funds target range from the 2.25%-2.50% established on December 19, 2018. The implementation note should not alter the present 3.00% discount rate, 2.35% IOER, or the 2.25% ON RRP offer rate. There will probably be nothing fresh on the decision to slow reinvestments in the balance sheet as the wind down to an end in September 2019 progresses. The FOMC will be discussing technical issues on this, but details will have to wait until Chair Powell comments in his press briefing and/or the release of the meeting minutes on July 10 at 14:00 ET.
For history of Federal Reserve rate decisions and votes, and a history of FOMC statement texts please see the Whetstone Analysis reference library.
The meeting statement should reflect moderation in economic activity and heightened uncertainties about the outlook, but also some bright spots related to consumer and business confidence, spending and residential real estate. Inflation and inflation expectations be less a concern than at the prior meeting. If it looks like the FOMC consensus is less inclined to provide a so-called insurance cut in rates, it is possible that St. Louis Fed President James Bullard will dissent in the vote.
Chair Powell is likely to get hammered with questions about a possible rate cut at the 14:30 ET press briefing, especially if the statement shows the FOMC hasn’t moved from the “patient” position of the April 30-May 1 meeting. Powell is adept at staying on message, so the line of questioning could be repetitive and unproductive.
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