What changed in the Jun FOMC
The Jun FOMC can be marked as an important pivot in Fed’s monetary policy stance. As we had explained in our June FOMC preview, in previous rate cut scenarios Fed had changed its assessment of economic activity to be rising at a “moderate pace”. Jun meeting was no different. The Committee made some important changes in its statement compared to the May meeting. Most notable of them are as follows: -
1. Economic activity is rising at a “moderate rate” (instead of “solid rate”),
2. Uncertainties have increased (about the Committee’s most likely outcomes),
3. The Committee will closely monitor the implications of incoming information….and will act as appropriate.
Despite above changes, the Jun meeting used following statements that were exactly same as in the May meeting: -
1. Labour market remains strong, job gains have been solid and unemployment rate has remained low,
2. The Committee continues to view sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective as the most likely outcomes.
There have been few comments from Fed members (some from voting members and some from non-voting members) since the Jun meeting. A quick snippet of some important comments are as follows: -
Brainard = Recent weeks have brought important downside risks for US economy, including political uncertainty.
Kaplan = Downside risks to US economic outlook have increased; too early to judge if trade, global growth uncertainties will hurt US economic growth; monthly US job gains of 60-120K would mean ‘strong’ jobs market.
Powell = Do not want to overreact to individual data; cross-currents have reemerged and incoming data raises concerns; economic conditions have changed significantly in last 6-8 weeks; better to act preemptively and not let an economic downturn gather steam.
Bullard = Good time for ‘insurance rate cut’; 50bps rate cut in Jul would be overdone.
Daly = Very confident in Fed’s ability to fight high inflation, less confident in ability to fight too-low inflation; next several weeks will provide more info; acting early to prevent rate falling to 0% is more effective than trying to move off zero rates later; headwinds and slowing growth could strengthen argument for rate cut.
Did anything change in the MPR, the Testimony and the Minutes?
The MPR (monetary policy report) submitted to the Congress on 5th Jul and the testimony to the Congress on 10th Jul and 11th July reiterated the following points already cited multiple times by Fed chair and other FOMC members: -
1. Labour market is strong; inflation continues to be below the Committee’s longer-run objective of 2%,
2. Baseline outlook is for economic growth to remain solid, labor markets to stay strong, and inflation to move back up over time to the Committee's 2% objective,
3. Uncertainties to the above economic outlook have increased,
4. The Committee will closely monitor and will act as appropriate,
5. Incoming data suggests moderate economic activity for Q2 despite pickup in consumption, which was week in Q1,
6. Growth in business fixed investment has slowed notably reflecting crosscurrents such as trade tensions and concerns about global growth.
Overall, nothing significantly changed in either of the three events. Fed chair mostly reiterated and hence confirmed the high chances of a rate cut.
What’s priced in?
So, broadly, from a “risk management” perspective or to err on the side of caution, we expect Fed to cut rates in the Jul FOMC by 25 basis points. We don’t expect Fed to go beyond the 25 basis points since this rate cut is about taking an action and watching the reaction of the economy simply because it might be too late if they do it in Sep meeting.
What has changed in the economy since the Jun meeting?
Let us look at some of the economic figures that have been released since the Jun meeting and see if they might provide any different stimulus to Fed’s overall economic assessment. Philadelphia Fed business index and consumer confidence was quite weak but University of Michigan sentiment index was better. Existing home sales was better but new home sales was weak. Both durable goods and factory orders were better. Chicago PMI, ISM manufacturing and non-manufacturing indexes were all weak. Initial jobless claims remain unchanged but continued claims have inched up slightly which seems to be part of a broad trend that has existed since mid-Apr. Change in non-farm payrolls for May, as per the revised figure, remained low but the Jun figure was above the running average for the year and hence was strong.
This backdrop of data substantiates that labour market continues to remain strong while confidence in the economy has subsided and so has manufacturing activity. Therefore, a look alone at the data also seems to favour a rate cut. Additionally, keep a watch on the following three economic indicators that will be released between now and the July FOMC meeting: -
1. Retail Sales
2. Jobless Claims
3. PCE and Core PCE Inflation
From a textbook perspective, a rate cut is warranted if: - a) low inflation sustains despite good growth, or b) economic growth falters or there are signs of distress potentially impacting future growth, or c) both. Fed, for some time, has found inflation to be a problem which has refused to inch north despite tight labour markets and solid economic activity in the first quarter of this year. The few FOMC participants who had favored a rate cut in previous meeting(s) had done so due to this fear of low inflation proving to be persistent. Now that crosscurrents have (re)emerged to the baseline outlook of the central bank, a rate cut is more of a done deal.
However, FOMC members have emphasized that this cut is more of an insurance against a later swift fall in economic activity; it is a risk management measure. This is not necessarily supposed to be the start of a rate cut cycle. Moreover, this change of stance has taken place due to reemergence of trade tensions, some not-so-encouraging-data and slowing global economic growth. These headwinds might change direction substantially before the 31 Jul FOMC meeting.
So, our base case scenario is for FOMC to deliver a 25 basis points cut in the Jul meeting and communicate clearly that this was an insurance cut and not the first of a new cycle. In the not so unlikely scenario, if the incoming economic data proves to be positive and trade tensions ease significantly, we might not see a cut in Jul meeting. There is an interesting side to this story though. Since Trump has been trying to influence Fed to cut rates and trade tensions seem to be one of the reasons why Fed has changed its stance, Trump might not resolve trade tensions deliberately before Jul meeting.
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