The confluence of Factors (Not Just Trade!) Point to Earlier Rate Cut

On Thursday, we issued a Change in the Call to reflect that we now think the first cut (25 basis points) will happen in September, followed by another cut (also 25 basis points) in Q1:2020. We were motivated to move up the expected timing of the first-rate cut by several reinforcing factors, including the soft inflation data, the disappointing domestic spending data, a weak global economic backdrop, the recent escalation in  China-U.S. trade tensions, and the tightening in financial conditions that have accompanied these developments. President Trump’s announcement on Friday of tariffs on all goods imported from Mexico (5%  beginning June 10, increasing to 25% by October) came after we’d already changed our call, but we see it as consistent with this earlier projected first rate cut. 

This week, as part of its review of monetary policy strategy, tools, and communications, the Fed is holding a  research conference in Chicago. Fed policymakers are on the official agenda only as hosts and moderators. 

Policymaker Remarks 

We interpreted Clarida’s speech (May 30) as suggesting that risks were tilted to the downside and that he sees a bias toward easing. He said that an increase in downside risks could suffice to warrant a cut: “If the  incoming data were to show a persistent shortfall in inflation below our 2 percent objective or were it to  indicate that global economic and financial developments present a material downside risk to our baseline  outlook, then these are developments that the Committee would take into account in assessing the  appropriate stance.” (Click here for our full commentary.) He further noted: “if we saw a downside risk to the  outlook, then that would be a factor that could call for a more accommodative policy.” He warned: “The inflation data had just been softer. We think that a lot of that may be transitory. But the reality is  that has been softer.” 

Other policymakers continued to adhere to the symmetric, patient policy stance. Daly (Jun. 2) said, “patience  is appropriate.” She has “some confidence” inflation will improve as the economy grows at a “strong pace.”  However, she said if growth slowed sharply and inflation did not look like it would recover sustainably, then the FOMC would have to discuss a potential rate cut. Even Kashkari, who is seen as very dovish, said he is  “not quite there yet” on the necessity of a rate cut. Quarles (May 30) seemed to suggest that financial stability  concerns would not be a hurdle for rate cuts, saying, “monetary policy should be guided primarily by the  outlook for unemployment and inflation and not by the state of financial vulnerabilities.” 

Williams (May 31) commented only generally about optimal strategy in the face of the zero lower bound,  noting that “short-term rates should be cut aggressively when deflation or a severe downturn threatens,”  without reference to the current circumstances. Also, “short-term rates should be kept ‘lower for longer as the economy recovers” and “the ZLB is likely to be an even more powerful force” with r-star being so low. 

The imposition of further tariffs on imports from China and President Trump’s announcement of tariffs on all goods imports from Mexico caught the attention of some policymakers. Daly saw “small upward pressure on inflation” as a result but did not see passthrough yet. Kashkari warned of adverse effects on business confidence. 

The recent yield curve inversion was also a topical issue. Daly noted that the inversion hasn’t been “sustained and deep,” so it does not signal recession. To her, the long end is being depressed by lower projected GDP  growth and flight-to-quality flows. Clarida wants to “distinguish between a flat curve and a curve that is  inverted and remains inverted for a period of time.” As of Thursday, “We really haven’t seen [a persistent  inversion] yet.” 

Nowcasts (2019:Q2) 

Source Current One Week Ago Two Weeks Ago
Atlanta Fed GDPNow 1.3% 1.3% 1.2%
New York Fed Staff Nowcast 1.5% 1.4% 1.8%
CNBC/Moody’s Survey 1.6% 1.8% 1.9%

Recent Data 

BEA made only minor revisions to Q1 real GDP. Overall real GDP growth was marked down a tenth, to 3.1%,  and the story remains that final private demand was weak in Q1, with strong positive contributions from inventories, net exports, and government consumption and gross investment boosting real GDP growth to such a strong rate. The annualized core PCE inflation rate in Q1 has marked down three tenths, to 1.0%.  The downward revision to core PCE prices in Q1 resulted in the 12-month core PCE inflation rate for March being revised down a tenth, to 1.5%, but a solid gain in core PCE prices in April brought the 12-month rate up to 1.6%. 

There were modest positive surprises last week, including the April goods trade and inventory data as well as an upward revision to real consumer spending in March, but the incoming data continue to suggest that real GDP growth slowed substantially in Q2. This morning’s construction spending report included upward revisions to the Q1 monthly data but showed that construction spending was flat in April, with a strong gain in public construction offsetting a decline in private construction spending that extended across both the residential and nonresidential categories. 

A couple of important measures of consumer sentiment released last week remained at very high levels in May.  The Conference Board index posted a strong increase, but it reflected data collected only through mid-May,  and therefore likely do not fully reflect the escalation in China-U.S. trade tensions that occurred around that time. The final Michigan survey results for April indicated that, while confidence remains at high levels, recent trade development are affecting consumer attitudes. The press release noted that “confidence significantly eroded in the last two weeks of May. The late-month decline was due to unfavorable references to tariffs,  spontaneously mentioned by 35% of all consumers in the last two weeks of May, up from 16% in the first  half of May and 15% in April and equal to the peak recorded last July in response to the initial imposition of  tariffs.”

Release Period Actual Consensus Revision to  Previous ReleasePreviously  Released Figure
FHFA House Price Index MoM Mar 0.1% 0.2% 0.4% 0.3%
S&P CoreLogic CS 20-City YoY NSA Mar 2.68% 2.50% 2.95% 3.00%
Conf. Board Consumer Confidence May 134.1 130.0 — 129.2
GDP Annualized QoQ 1Q S 3.1% 3.0% — 3.2%
Personal Consumption QoQ 1Q S 1.3% 1.2% — 1.2%
GDP Price Index 1Q S 0.8% 0.9% — 0.9%
Core PCE QoQ 1Q S 1.0% 1.3% — 1.3%
Advance Goods Trade Balance Apr -$72.1b -$72.7b -$71.9b -$71.4b
Retail Inventories MoM Apr 0.5% 0.2% — -0.3%
Wholesale Inventories MoM Apr P 0.7% 0.1% 0.0% -0.1%
Pending Home Sales MoM Apr -1.5% 0.5% 3.9% 3.8%
Personal Income MoM Apr 0.5% 0.3% — 0.1%
Real Personal Spending Apr 0.0% 0.0% 0.9% 0.7%
PCE Prices MoM Apr 0.3% 0.3% — 0.2%
PCE Prices YoY Apr 1.5% 1.6% 1.4% 1.5%
Core PCE Prices MoM Apr 0.2% 0.2% 0.1% 0.0%
Core PCE Prices YoY Apr 1.6% 1.6% 1.5% 1.6%
U. of Mich. Sentiment May F 100.0 101.5 — 102.4
U. of Mich. 5-10 Yr Inflation May F 2.6% — — 2.6%
ISM Manufacturing May 52.1 53.0 — 52.8
Construction Spending MoM Apr 0.0% 0.4% 0.1% -0.9%

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