By Robert Eisenbeis, Ph.D.
To no one's surprise, the FOMC declined to increase rates at its July meeting. There are few substantive differences between the Committee's July statement and its June statement. However, the FOMC did note this time that job gains were strong after a dismal performance in May, economic growth was seen as moderate, and labor utilization had improved. On the downside was the underperformance of corporate investment and inflation is still far below the Fed's target of 2% for the PCE headline number.
In both the June and July statements, the Committee indicated that it would be monitoring inflation and international developments, and both Chair Yellen in her June press conference and the FOMC June minutes devoted significant attention to the international situation and Brexit. International concerns were clearly an important consideration in July as well, but we'll have to wait until the minutes are released to get a read on how subsequent international developments were regarded. This includes the fact that the Bank of Japan kept rates steady at its June policy meeting, continuing its negative interest rate policy. But foreign currency markets responded with a sharp appreciation of the yen before tapering off a bit, and the dollar depreciated against the euro in the week before the July meeting.
The dissent of President Esther George of the Federal Reserve Bank of Kansas City from the FOMC's decision to hold pat may represent an early signal with regard to the Committee's thinking about rates going forward. She has dissented for most of her tenure at the Kansas City Bank but had voted with the majority in June not to raise rates. That she is now back to advocating another rate increase may signal that the general tone of the Committee's discussion was more positive than it was in June as far as the rates outlook is concerned.
So what can we expect going forward? Well, the Committee has maintained its data-dependent stance, which provides little or no relevant information to markets about its current thinking. But markets did respond to the Committee's somewhat more positive view on the economy and labor markets by pricing in another move by the FOMC sometime this year. The question is, if the rate increase happens, when will it happen? September will be an important meeting in a couple of respects. First, the Committee will have had two readings on Q2 GDP, whereas now it has nothing. Interestingly, had the FOMC met next week rather than this week, it would at least have had the first reading on Q2 GDP, which is scheduled to be released on July 29. Second, it will have more data on labor markets and how international markets may be faring.
In November, the FOMC will also have a reading on GDP for Q3, which would make November a prime candidate for the next FOMC rate hike, were it not for the presidential election, which occurs only a couple of days after the Committee's November meeting. It is not likely that the FOMC would move then, given the importance of economics to the current election outcome, since a move might be interpreted as favoring one party or the other. So, the next most likely time for a rate hike is really not until December, when the FOMC will have a lot of information on the economy, employment, and progress towards its inflation objective.
What will be the most important indicator to watch? That will be the progress towards the Committee's 2% inflation objective. It is hard to see a move until that number really threatens to burst through the target. And that is actual reported inflation, not some inflation forecast. At Cumberland, we continue to be cautious and have defensively positioned portfolios to reflect this caution.