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What a difference to Fed chairman Ben Bernanke's testimonial the latest FOMC minutes make. Ahead of midterm elections it is clear that Bernanke's appearance on Capitol Hill was dominated by a strategy of staying out of president George Bush's firing range. The FOMC minutes from the June meeting sound different altogether. Slowing growth and persisting inflationary pressures put the Fed between a rock and a hard place.

Some quotes:

  • ... growth of economic activity in the second quarter slowed substantially from its rapid first-quarter pace.
  • The expansion of consumer spending softened, and activity in the housing market continued to cool.
  • Gains in nonfarm private payrolls averaged 112,000 over the three months ending in May, a pace considerably below the average of about 170,000 jobs...
  • For the year to date, manufacturing production advanced at a rate significantly below its rapid fourth-quarter growth rate but only a bit below its average pace of expansion since mid-2003.
  • Real consumer spending appeared to be on track to decelerate noticeably in the current quarter...
  • The level of nominal wages and salaries beginning in the fourth quarter of 2005 was revised down considerably, and rising consumer prices held down the gains in real disposable income.
  • Higher interest rates also likely restrained spending.
  • Residential construction activity moderated over the past few months but remained at a historically high level.
  • The U.S. international trade deficit widened in April, reflecting a large increase in imports coupled with a slight decline in exports.
  • Headline inflation picked up in April and May, driven partly by sharp increases in the prices of petroleum-based products.
  • Core price inflation rose less than headline inflation in April and May but above its pace earlier in the year.
  • ...participants observed that housing construction activity had declined notably in recent months as indicated by lower housing starts and permits; moreover, higher inventories of unsold homes, a sharp rise in cancellations of new home sales, and reports from construction companies suggested that the weakness was likely to be extended.
  • Participants also observed that the evidence to date indicated that the slowdown was orderly but were mindful of the possibility of a sharper downturn in the (real estate) sector.
  • The growth of consumer spending had dropped off significantly in the second quarter from a robust pace earlier in the year. The slowdown was attributed in part to higher energy prices and also to a likely downshift in home price appreciation and higher interest rates.
  • All meeting participants expressed concern about recent elevated readings on core inflation.

It appears the FOMC finally acknowledges there are problems with inflation, housing, and consumer spending, given the sharp words with only a few drops of hope in and between.

Confirmed by the weakening trend in economic data the Fed finds itself confronted with the need for the impossible in the run-up to the next FOMC meeting on August 8. Lower growth expectations rub with inflationary pressures nobody sees going away in the short term, which would need a cut and a hike at the same time.

Including seasonal factors like the increased appearance of market drops in autumn I would not be surprised to see the Fed continue its 17 steps long path of 25 basis point advances at the next meeting to be able to offer some temporary comfort at a later stage, once consumer sentiment nosedives.

The rate trend will stay the same and probably accelerate once investors rediscover the meaning of the term real interest.

Source: FOMC Minutes Talk Shop