Dissecting July's FOMC Statement: What Changed?

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Includes: DIA, IWM, QQQ, SPY
by: JP Research

Summary

Fed adds a key quote - “Near-term risks to the economic outlook have diminished".

Strong economic conditions and easing financial conditions keep the Fed on hold and upbeat.

For now, it seems one rate hike in December should be the most likely scenario.

Any guidance for a September hike will probably come at the Jackson Hole Conference in August.

Shifting of median 2016 Fed funds forecast to just one hike from the prior median forecast of two hikes could function as a shock absorber.

Themes

June

July*

Economic assessment

The pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up.

Although the unemployment rate has declined, job gains have diminished.

Since the beginning of the year, the housing sector has continued to improve and the drag from net exports appears to have lessened, but business fixed investment has been soft

Market-based measures of inflation compensation remain low;declined; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.

Information received since the Federal Open Market Committee met in June indicates that the labor market strengthened and that economic activity has been expanding at a moderate rate.

Job gains were strong in June following weak growth in May. On balance, payrolls and other labor market indicators point to some increase in labor utilization in recent months. Household spending has,been growing strongly but business fixed investment has been soft.

Market-based measures of inflation compensation remain low; most survey based measures of longer term inflation expectations are little changed, on balance, in recent months.

Dual mandate and balance of risks

The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen.

Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further.

Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further. Near-term risks to the economic outlook have diminished.

Forward guidance and balance sheet policy

The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.

The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.

Votes

"Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Esther L. George; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo."

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo.

Voting against the action was Esther L. George, who preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.

The key takeaway from the July FOMC statement was the addition of the following sentence:

"Near-term risks to the economic outlook have diminished."

Why diminished? Firstly, economic data has been strong. Economic data for May was weak hence the minutes from the subsequent FOMC meeting revealed that the Committee was concerned whether the slowdown in employment growth in May had broader implications for the economy. Economic data released since then has been much stronger, showing a rebound in employment growth and solid retail sales in June. The emphasis on "near term" risks is an important qualification as the US economy faces a number of significant risks beyond the next few months. July's FOMC statement did not indicate explicit concern about long-term risks but by singling out the "near-term", it implied that the Committee's concerns about other risks remain.

Secondly, financial conditions have eased since the last FOMC meeting, in spite of the Brexit vote. The dollar has appreciated since the last FOMC meeting. However, other aspects of financial conditions have eased notably since mid-June. The latest statement indicates that the FOMC believes the long-term consequences to the US of the UK "leave" vote are minor. Despite the newfound optimism, the July statement does not imply a rate hike will be forthcoming at the next meeting. Any guidance for a September hike will probably need to come at the Jackson Hole Conference, where Yellen speaks on August 26th. For now, it seems one rate hike in December should be the most likely scenario.

Additionally, reintroducing "risk" language back into the statement should help the FOMC guide market expectations through year-end. The reintroduction echoes the October 2015 FOMC meeting which featured the line "The Committee continues to see the risk to the outlook…as nearly balanced". At the subsequent meeting, the statement indicated they saw the "risks to the outlook…as balanced". This language was accompanied by a hike. The return of the risk language to the FOMC statement could be setting the stage for the FOMC to follow a similar path but not necessarily for a subsequent hike. Barring any external shocks, the next FOMC statement (in September) could be used to reset expectations. Noting that risks are "nearly balanced" for instance, could signal a forthcoming rate hike. The "dots" could be used as a shock absorber in the event of a hike as the median 2016 Fed funds forecast has been shifted to just one hike from the prior median forecast of two hikes.

It is also worth noting that the most hawkish FOMC member, Kansas City Fed President George, dissented from the status quo, preferring to raise interest rates instead. The next meeting in September could well be a "live" one depending on what comes out in their respective speeches but December remains the most likely option for the Fed.

The final view is that the Fed will do a "2015" i.e. 25bps hike at the final FOMC meeting on 13-14 Dec 2016 after the Presidential Election.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.