Notes From July Meeting
At their July rates meeting the Federal Reserve opted to maintain policy at current levels, in line with market expectations. With no updating of the FOMC forecasts and no press conference, the only means of communication available at this meeting was the statement accompanying the decision.
The Fed struck a positive tone in the statement noting that near term economic risks have diminished with economic activity expanding at a moderate pace and labour market having strengthened. Inflation however was noted as remaining low and likely to remain so in the near term though expected to rise to the Fed’s 2% target in the medium term as transitory effects fade.
Household spending was noted to be growing strongly though Business fixed investment remains soft.
Referring to the rate path the Fed noted that they still see only gradual increases in the federal funds rate as being appropriate though the actual rate path will depend on incoming data.
One further bullish development was seen in the voting split which changed from unanimously in favour of keeping rates on hold to 9-1 in favour of rates on hold with Kansas City Fed’s George voting in favour of a hike at this stage.
July FOMC Meeting Minutes
July’s FOMC meeting minutes provide little indication of the timing of the next rate hike as members remained divided over whether to raise interest rates soon. The minutes stated that near term risks have diminished, leaving room for a hike this year if economic data continued to point to a resilient US economy.
On labour market conditions, most committee members “saw relatively low risk that a further gradual strengthening of the labour market would generate an unwanted increase in inflationary pressures,” but they still prefer to “defer another increase until they were more confident that inflation was moving closer to 2% on a sustained basis”. Some fed officials raised concerns on Brexit as it “creates uncertainty about medium to longer run outlook for foreign economies that could affect economic and financial conditions in the United States”.
Data & Developments
- 2Q GDP 1.2% vs 2.5% expected
- 2Q Personal consumption 4.2% vs 4.4% expected
- July ISM Manufacturing 52.6 vs 53 expected, Non Manufacturing 55.5 vs 55.9 expected
- July NFPs 255k vs 180k expected
- July Retail Sales 0% vs 0.4% expected
- July Core CPI 2.2% vs 2.3% expected
- July Durable goods 4.4% vs 3.4% expected
- ISM Manufacturing August 49.4 vs 52, Non manufacturing 51.4 vs 54.9 expected
- August Unemployment rate 4.9% vs 4.8% expected
- August NFPs 151k vs 180k expected
- August Average Hourly Earnings 2.4% vs 2.5%
- August retail sales -0.3% vs -0.1% expected
- August core CPI 2.3% vs 2.2% expected
Over the last two months we have also heard from a raft of Fed members who have voiced their opinions on the prospects of a rate hike and the likely US rate path for the remainder of the year. The majority of these comments have been in support of a rate hike.
- Fed’s Williams noted that “The economy has climbed back to full strength, and it therefore makes sense to move monetary policy gradually back to normal,” adding that “In the context of a strong economy with good momentum, it makes sense to get back to a pace of gradual rate increases, preferably sooner rather than later.”
- Fed’s Bullard also spoke in support of a hike noting that he “can see two rate hikes as possible “ before year end.
- Fed’s Rosengren, traditionally a Dove urged for action sooner rather than later saying that “A failure to continue on the path of gradual removal of accommodation could shorten, rather than lengthen, the duration of this recovery,”
- Fed’s Fischer, another proponent of hiking sooner rather than later, noted that “we are close to our targets” and that “Looking ahead, I expect GDP growth to pick up in coming quarters, as investment recovers from a surprisingly weak patch and the drag from past dollar appreciation diminishes,”. These comments further increased rate hike expectations.
- Fed’s Mester reiterated comments made by Fed’s Rosengren noting that If you inappropriately keep interest rates too low for too long then you put yourself in a position of perhaps having to raise interest rates more strongly in the future” adding that she feels there is a “compelling case” for raising rates.
There are divisions among the Fed however and alongside these Hawkish comments we have also had arguments against raising rates with Fed’s Brainard urging caution in the removal of accommodative monetary policy adding that the case for pre-emptively tightening is “less compelling”.
These comments were backed up by Fed’s Powell who also urged patience and the need to wat for inflation to move back to target.
Headline comments over the period came from Fed Chair Yellen who, speaking at the Jackson Hole symposium, noted that “In light of the continued solid performance of the labour market and our outlook for economic activity and inflation, I believe the case for an increase in the federal-funds rate has strengthened in recent months.”
Expectations For This Meeting
Fed rate hike expectations have fluctuated quite a lot over the summer creating difficult trading conditions. And you can see that represented clearly here by the peaks and troughs in positioning. In terms of outlining a base case for this month’s meeting, it seems The disconnect between recent data and supportive Fed commentary suggests that the Fed are on course to raise rates this year but that September is likely too early.
Whilst Inflation has started to tick up, it is still well below target level and is a cause for concern for many Fed members. The recent uptick is likely to be an encouraging sign and if momentum continues, should further support the case for a rate hike this year but at current levels, doesn’t justify a rate hike in September.
Labour market conditions have shown some weakening with the pace of monthly job growth falling from around 250,000 in the second half of 2014 to around 175,000 over the last six months. However, despite this deterioration in pace, jobs growth remains well above the Fed’s “sustainable rate” which is the level which maintains the constant gap between the unemployment rate and the natural rate.
The growth picture is also challenging with overall economic activity remaining at modest levels. GDP Growth currently sits at just 1.1% only marginally off the lowest levels of the last four years. The weakened business investment outlook for the remainder of the year threatens to further weigh on growth.
The upcoming US election also presents risks for the Fed. The potential election of maverick Republican candidate Donald Trump presents a great deal of uncertainty. Trump has noted his intentions to boost fiscal stimulus derived from significant tax changes which could boost inflation and thus warrant a steeper rate path. However, the Fed are likely to want to wait and see how the election plays out before committing to a course of action, especially since Trump has fallen back in the polls over summer.
So in summary, base case scenario is – not expecting the Fed to raise rates tomorrow but expecting a clear Hawkish tilt to the statement with the Fed outlining that they are moving close to raising rates and foresee a rate rise before the year end providing support for the US Dollar.