Soon After First Cut, Trade War Escalation Increases Likelihood of Further Easing

The past week has been eventful, to say the least. The July 2019 FOMC Meeting confirmed our expectations that the FOMC and Powell would start with an initial rate cut of 25 basis points but do their best to keep their options for the September meeting. However, that was soon followed by an escalation in trade tensions that changed our baseline view. The White House announced it would impose additional tariffs on Chinese imports, and China responded promptly both by instructing state firms to halt purchases of U.S. agricultural products and by allowing the renminbi to depreciate. As a result, we pulled forward the expected timing of a  second rate cut this year (which we had already been assuming) into September, and now see a higher likelihood of a third rate cut this year. See Change in the Call: Second Cut in September, Third 2019 Cut  More Likely

Policymaker Remarks 

All but two FOMC members agreed with the decision to cut the fed funds rate by 25 basis points. Following the meeting, the two dissenting members explained their opposition to the Committee’s decision. Rosengren  (Aug. 2) said he did not “see a clear and compelling case for additional monetary accommodation at this  time,” “With the unemployment rate near 50-year lows and inflation likely to rise toward the 2 percent target,  and with financial stability concerns being somewhat elevated given near-record equity prices and corporate  leverage.” He provided a series of charts to justify his view. He cited both macroeconomic indicators (low unemployment, 2% trimmed-mean inflation, and above-potential GDP growth) and financial stability indicators  (equities at “all-time-highs” and corporate leverage “near an all-time high”). George (Aug. 2) noted that  “Incoming economic data and the outlook for economic activity over the medium term warranted no change  in the policy rate.” In her view, the “moderation” of growth in 2019 was expected and did not warrant a rate cut: “The moderation of economic growth in 2019 is in line with my outlook that calls for a gradual decline to a trend level over the medium term. With moderate growth, record low unemployment, and a benign  inflation outlook, maintaining the committee’s policy settings at 2.25%-2.5% would have been appropriate.” 

Between Rosengren and George, we had seen Rosengren as more likely to dissent at the July FOMC meeting.  George seemed to be slightly less forceful than Rosengren in her opposition, noting explicitly that “Should  incoming data point to a weakening economy, I would be prepared to adjust policy consistent with the Federal  Reserve’s mandates for maximum sustainable employment and stable prices.” She cited some of the concerns  that are broadly shared among policymakers: “There are certainly risks to the outlook as the economy faces  the crosscurrents emanating from trade policy uncertainty and weaker global activity.” 

Nowcasts (2019:Q3) 

Source Current
Atlanta Fed GDPNow 1.9%
New York Fed Staff Nowcast 1.6%
CNBC/Moody’s Survey 1.9%

Recent Data 

In addition to the significant economic policy developments last week there was also a large amount of incoming economic data. We saw the July jobs report as solid overall, but with some notable weakness in hours. Job growth has continued at a good pace—slower than in previous years but with no abrupt dropoff that would raise concerns—and the unemployment rate remains very low. We covered the July jobs report in more depth in a separate note (link). 

The 12-month core PCE inflation rate was 1.6% in June. While that’s a tenth lower than had been expected before BEA releasing quarterly data reflecting annual revisions, the trajectory of core PCE inflation looks essentially the same: a string of soft readings early this year followed by much firmer monthly readings in the second quarter. The ECI for total private compensation was a little softer than the consensus in Q2, advancing  0.6%, and the one-year change fell a couple of tenths to 2.6%, somewhat further below the cycle high of 3.0%  reached at the end of 2018. 

Last week’s incoming survey data continued to point to a divergence in sentiment between consumers and businesses. The Conference Board consumer confidence index surged in July after a drop in June while the final July print for the University of Michigan measure was unchanged from the preliminary print. Both measures have been moving roughly sideways at high levels over the last couple of years, with downward moves in sentiment proving to be short-lived. In contrast, the ISM manufacturing index, like other manufacturing surveys, is well below levels in mid-to-late-2018. Last week it was reported to have edged down further in July, though it remains at a level representing expanding activity. The core capital goods data, both orders, and shipments were also revised down last week relative to the advance report, though these data still show a return to growth in core orders in recent months. The construction data were likewise a disappointment, showing a 1.3% decline in total spending in June. Public spending declined most sharply,  a second consecutive monthly decline following strong growth over the first four months of the year, but private spending was weak as well, declining 0.4%.

Release Period Actual Consensus Revision to  Previous ReleasePreviously  Released Figure
Personal Income MoM Jun 0.4% 0.4% 0.4% 0.5%
Personal Spending MoM Jun 0.3% 0.3% 0.5% 0.4%
Core PCE Prices MoM Jun 0.2% 0.2% — 0.2%
Core PCE Prices YoY Jun 1.6% 1.7% 1.5% 1.6%
Pending Home Sales MoM Jun 2.8% 0.5% — 1.1%
Conf. Board Consumer Confidence Jul 135.7 125.0 — 121.5
Employment Cost Index QoQ 2Q 0.6% 0.7% — 0.7%
ISM Manufacturing Jul 51.2 52.0 — 51.7
Construction Spending MoM Jun -1.3% 0.3% -0.5% -0.8%
Wards Total Vehicle Sales Jul 16.82m 16.90m — 17.30m
Change in Nonfarm Payrolls Jul 164k 165k 193k 224k
Unemployment Rate Jul 3.7% 3.6% — 3.7%
Average Hourly Earnings MoM Jul 0.3% 0.2% 0.3% 0.2%
Average Hourly Earnings YoY Jul 3.2% 3.1% — 3.1%
Average Weekly Hours All Employees Jul 34.3 34.4 — 34.4
Labor Force Participation Rate Jul 63.0% 62.9% — 62.9%
Trade Balance Jun -$55.2b -$54.6b -$55.3b -$55.5b
Core Capital Goods Orders MoM Jun F 1.5% — — 1.9%
Core Capital Goods Shipments MoM Jun F 0.3% — — 0.6%
U. of Mich. Sentiment Jul F 98.4 98.5 — 98.4
U. of Mich. 5-10 Yr Inflation Jul F 2.5% — — 2.6%
ISM Non-Manufacturing Index Jul 53.7 55.5 — 55.1

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