Risks Still Warrant Fed Easing in July

The announcement that further U.S. tariffs on Chinese imports will be postponed as trade negotiations between the U.S. and China resume will be welcomed by the FOMC. However, such an outcome from this weekend’s G-20 summit was widely anticipated, and while a reprieve from these additional tariffs removes one immediate downside risk related to trade, the prospects for a comprehensive resolution of trade tensions seem little changed. Considerable uncertainty on U.S.-China trade remains, and the global economic outlook still looks weak. Furthermore, other political risks such as Brexit and USMCA have yet to be resolved. While the U.S. economy still looks in better shape than other advanced economies, manufacturing has been weak and business sentiment has dipped. With core inflation soft and questions about too-low inflation expectations, overheating is an unlikely scenario and one the FOMC could address should it arise. That  consideration means that there is a high bar for the June jobs report later this week to shift the risk 

management calculus facing the FOMC. We continue to see a high probability that the FOMC will cut the fund’s rate by 25 basis points in July. 

Policymaker Remarks 

We saw Powell’s remarks (Jun. 24), which came before the G-20 summit, as reinforcing a high probability of a rate cut at the July 31 FOMC meeting: “What’s happened is things have changed since May 1—significantly.  The global risk picture has changed really in the last six to eight weeks, and it’s around trade developments  and global growth.” He also mentioned other familiar, reinforcing reasons for accommodation: falling market 

based measures of inflation expectations, disappointingly soft core inflation, weak manufacturing in the U.S.  and globally, and weaker business sentiment. See our commentary for the complete analysis. 

Other policymakers weighed in on the possibility of near-term rate easing. They generally adopted a wait-and-see posture, holding out hope that recent downside risks might dissipate soon. Daly (Jun. 26) cited as concerns trade uncertainty, weak inflation, and a weak jobs report, but she noted that these risks could abate:  “Let’s watch the next six weeks and see if the data reverse,” and “see how the uncertainty resolves itself as we get more information about trade negotiations, and finally, let’s see what other countries are doing to offset potential weaknesses” (Jul. 25). A rate cut, “should it be required, would be stimulating the economy  to get it back up to what we think of as potential growth.” She saw the labor market as “very tight” but was  “uncomfortable with not only the level of inflation currently but the direction,” so she advocated doing more to get inflation back to 2%. Barkin (Jul. 1) thought “We’re still in a very sound place” and that “emotions  have gotten far out in front of the data in terms of where we sit in the economy.” He said it was still too soon to prejudge the need for a rate cut at the July meeting. As long as consumption remains strong even if the investment is flat, that would not be “nerve-wracking.” He saw the current funds rate as “modestly accommodative” (Jun. 25). He cautioned against excessive optimism following the G-20 U.S.-China truce:  “regardless of how these conversations play out, they’ve concluded that trade tensions with China will be a  feature of our future environment no matter how this week goes.” Bullard (Jun. 25), who dissented in June,  wants a 25bp July cut and said a 50bp cut would be excessive. He also warned that a benign G-20 outcome  would not change downside inflation risk: ”The idea of re-centering inflation and inflation expectations is not  that dependent on what happens in Osaka.” Clarida (Jul. 1) reiterated the FOMC’s plan to “act as appropriate”  to “sustain the economic expansion.” 

There was also some new information about the trajectory of the balance sheet. Powell, in his press  conference following the June meeting, seemed to suggest that the FOMC might end runoff earlier if it cuts  rates before the planned end of runoff: “we’ll always be willing to adjust balance sheet policy so that it serves  our dual-mandate objectives.” But last week other FOMC participants leaned toward keeping the runoff plan intact (end runoff in September). Bullard said, “I don’t see a need to tinker with [the balance sheet plan] … I  would like to keep the focus on the main policy tool.” Daly, too, said continuing to reduce the balance sheet  “in my judgment doesn’t counteract or contradict policy…This has been well-telegraphed, well-announced,  so many of the effects of the balance-sheet runoff to ample reserves is already in the markets.” 

Nowcasts (2019:Q2) 

Source Current One Week Ago Two Weeks Ago
Atlanta Fed GDPNow 1.5% 2.0% 2.1%
New York Fed Staff Nowcast 1.3% 1.4% 1.4%
CNBC/Moody’s Survey 1.8% 1.9% 1.9%

Recent Data 

BEA reported that real GDP growth in Q1 was 3.1%, unchanged from its previous estimate. There were only minor revisions to final private demand, net exports, inventories, and government consumption and gross investment. Final private demand growth was marked up slightly, as a four-tenth downward revision to real  PCE growth, to 0.9%, was more than offset by slightly stronger residential investment and business fixed investment. 

Recent incoming monthly data suggest real GDP growth slowed to well below 2% in Q2, however, and reinforce the case for a somewhat easier monetary policy setting. The biggest development last week was a  surprisingly large widening in the goods trade deficit in May. Core capital goods orders advanced 0.4% in  May, somewhat more than expected, but that only partially reversed the 1% decline in April. It looks like Q2  was another weak quarter for equipment spending. This morning’s construction spending report showed a  large decline in May, though this disappointment was mitigated by an upward revision to April’s figure. 

There was some slightly positive news concerning inflation and inflation expectations last week, but nothing close to fundamentally changing the inflation picture confronting monetary policymakers. Core PCE  inflation in Q1 was marked up very slightly, and a moderate gain in core PCE prices in May kept the 12-month  rate at 1.6%. In the final Michigan survey for June, the measure of longer-term inflation expectations was marked up to 2.3% from a preliminary figure of 2.2%, which was the lowest ever reading for that series. 

Recent survey data have also continued to point to a deterioration in business sentiment while presenting a more mixed picture concerning consumer sentiment. The Conference Board consumer sentiment measure declined quite sharply in June, while the Michigan measure weakened only slightly and in any case remains at quite a high level. This morning’s ISM report showed only a slight further decline in the headline composite in June, but there’s been a clear and sustained decline from the expansion highs reached in late 2018. 

Release Period Actual Consensus Revision to  Previous ReleasePreviously  Released Figure
New Home Sales MoM May -7.8% 1.6% -3.7% -6.9%
Conf. Board Consumer Confidence Jun 121.5 131.0 131.3 134.1
Core Capital Goods Orders MoM May P 0.4% 0.1% — -1.0%
Core Capital Goods Shipments MoM May P 0.7% 0.1% 0.4% 0.0%
Advance Goods Trade Balance May -$74.5b -$71.8b -$70.9b -$72.1b
Wholesale Inventories MoM May P 0.4% 0.5% 0.9% 0.8%
GDP Annualized QoQ 1Q T 3.1% 3.2% — 3.1%
Personal Consumption QoQ 1Q T 0.9% 1.3% — 1.3%
Core PCE QoQ 1Q T 1.2% 1.0% — 1.0%
Pending Home Sales MoM May 1.1% 1.0% — -1.5%
Personal Income MoM May 0.5% 0.3% — 0.5%
Real Personal Spending MoM May 0.2% 0.4% 0.2% 0.0%
PCE Prices MoM May 0.2% 0.2% — 0.3%
PCE Prices YoY May 1.5% 1.5% 1.6% 1.5%
Core PCE Prices MoM May 0.2% 0.2% — 0.2%
Core PCE Prices YoY May 1.6% 1.5% — 1.6%
U. of Mich. Sentiment Jun F 98.2 97.9 — 97.9
U. of Mich. 5-10 Yr Inflation Jun F 2.3% — — 2.2%
ISM Manufacturing Jun 51.7 51.0 — 52.1
Construction Spending MoM May -0.8% 0.0% 0.4% 0.0%

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