In the last two or three FOMC meetings, it was increasingly harder for the officials to communicate their decisions properly to the markets. Teetering market expectations fed by conflicting economic and sentiment signals have been especially vulnerable to Fed’s communication mistakes. Recall Fed’s Williams speech about possible response to recessions which market took as a clear guide for a rate cut by 50 basis points. Thankfully, Fed’s spokesman was quick to issue disproof which averted disaster.
The economy and expectations (especially corporate sentiments) are sending conflicting signals, pulling the blanket of monetary policy to each other what makes it difficult for the Fed to be consistent, predictable and adhere to the line of its own medium-term forecasts. It is unknown from where the next shock will appear, which may either prolong the expansion or drive the economy into crisis.
Based on the premise of “data dependence” in determining the policy course, as Powell recalled at the previous meeting, the data for the last month can shed light about possible Fed decision this week. In the following table I compiled recent soft and hard data (statistical data and surveys), two multidirectional vectors which puzzle the Fed:
The big surprise, what complicates matters for the Fed is the acceleration of GDP, retail sales and jobs growth in July. The tax cuts were supposed to run out of steam in 1Q – 2Q of 2019, moreover, the trade war should have quickly depleted this driver of growth. Over the past three months, there has been some improvement in orders for durable goods and capital goods while sales of existing houses have also stabilized.
Surveys of company managers, on the contrary, indicate a fall in optimism in the outlook for demand and investments. So far, these fears “miraculously” haven’t translated into the employment figures, which is growing at relatively robust pace. The growth of layoffs and the slowdown in creating new jobs usually follow in response to declining sales but based on the current state of employment this is clearly not the case. However, Powell has previously stressed that employment, while remaining an important factor in macroeconomic stability, is pushed to the background in terms of forecasting ability. Prolonged decline in unemployment and the weak inflation response in wages and consumer prices show that any obvious connection between them has been lost. Since the pursuit of inflation targets remains the primary task for the Fed, soft monetary policy can now occur simultaneously with the strengthening of the labor market.
By cutting the rate, the Fed will also have to get rid of the stigma of “Trump’s puppet”, since the possible easing of credit conditions will follow precisely Trump’s numerous reproaches that the Fed is holding rates too high.
Important point of the July meeting is the absence of updates on the dot plot, i.e. signal about the long-term plans of the officials. This speaks in favour of dry wordings a la “act as appropriate”, since Powell will have to explain only the “statement” in which officials usually interpret past changes.
Another factor restraining ability to ease policy – inflated stock market which recently renewed historical peaks. It is likely that Powell will again add the phrase about a slightly “stretched valuations”, which also rules out “big rate cut” scenario without obvious recession risks.
There are two days left before the meeting, however futures continue to price high chance of easing by 50 bp. – at 23%. With such expectations the rate cut by 25 bp and reiteration of “patient” stance with scant explanations should be a bullish surprise, what is my current baseline scenario. In this case, we should expect a positive dollar response to the meeting.