June 21, 2019
The Fed did not change rates at the latest FOMC meeting. And while it is clearly leaning towards lower rates it has not yet reached that decision. Fed Chair Powell repeatedly noted that the incoming data will determine whether the Fed pulls the trigger.
It turns out there is a surprisingly wide gap in the views of FOMC members. At the moment, eight members believe that rates will be unchanged between now and yearend, but seven other members are looking for two rate cuts between July and December. So, sit tight and do nothing or cut rates twice. Those two views are diametrically opposed to each other.
Powell noted that at the time of the May FOMC meeting the U.S. and China were on the cusp of a trade agreement but that agreement fell apart. From the Fed’s perspective that heightened uncertainty about the trade outlook. So, what’s next?
So, as we see it the Fed has outlined two scenarios. First, Trump further raises tariffs on Chinese goods which weakens global growth (mostly outside of U.S. borders) and could imply a further drop off in the inflation rate from its 2.0% target path. In that event, the Fed might cut rates a couple of times between now and yearend. Or, at the upcoming G-20 summit meeting Trump and Xi choose not to further escalate the tariff war, agree to resume their discussion and, hopefully, find a way to resolve their differences. In that case, the Fed would most likely leave rates unchanged between now and December.
In the past the FOMC’s decisions were based on their assessment of economic conditions. How are GDP and inflation evolving relative to what it expected, and are any rate adjustments required to return to the desired path? The operating assumption was that fiscal and trade policy would be unchanged. They would incorporate changes in either type of policy after the fact. Once those changes occurred, the Fed would determine their impact on the economy and adjust accordingly. Now the path going forward seems to depend largely on policy decisions made by the current president which may, or may not actually occur. That is an exceedingly difficult task because one can envision any number of relatively plausible scenarios. Whether the Fed should base monetary policy on potential changes in the president’s fiscal or trade decisions, it has clearly chosen to go down that path.
So, where does that leave us? Everybody will be scouring the economic tea leaves between now and the July 30-31 FOMC meeting. These events/economic indicators will be crucial.
- The outcome of the June 28-29 summit meeting. If China and the U.S. agree to restart trade discussions, the no-change group at the Fed will gain support.
- The personal consumption expenditures deflator for May on Friday, June 28. This is the Fed’s preferred inflation target so whatever happens will be important. We are looking for an increase in the core rate of 0.2%. This outcome would cause the year-over-year increase to slip from 1.6% to 1.5%, but for the most recent 3-month period the run-up would climb to 1.9%. Perhaps a bit of ammo for both sides.
- The purchasing managers’ index for June on Monday, July 1. After reaching a high of 60.8 in August of last year it has been trending downward and now stands at 52.1 which is, presumably, consistent with GDP growth of 2.4%. We expect a modest increase to 52.5 which would suggest that the beleaguered manufacturing sector of the economy is not deteriorating further. A decline would give the rate-cutters at the Fed more ammo.
- The June employment data released on Friday, July 5. The weaker-than-expected increase in payroll employment for May of 75 thousand was disquieting. Will the June data be equally subdued? For what it is worth, we anticipate an increase of 170 thousand which would provide support for the no-change camp.
- CPI data for June on Thursday, July 11. While the Fed’s specific inflation target is the core PCE deflator, the concern about the continuing inflation shortfall will focus attention at the CPI as well. We expect to see a June increase in the core CPI of 0.2% which would leave the year-over-year rate at 2.0%. That outcome would leave the inflation outlook uncertain. No hint of a pickup but, no further shortfall either.
- Second quarter GDP growth on Friday, July 26. Following 3.1% growth in the first quarter we anticipate second quarter growth of 1.5%. That probably provides some support for both groups. Growth in the first half of the year would be 2.3% which would exceed the Fed’s estimate of potential GDP growth which is currently 1.9% and suggest no further rate cuts are necessary. But 1.5% growth in the second quarter could encourage the rate-cut camp.
Our sense is that if the data unfold as described above, the FOMC will – once again – chose to leave rates unchanged on July 31 and await further data. The market’s two expected rate cuts between now and December are expected at the meetings in September and December. As always, the data will determine the outcome.