While the Minutes to the July Federal Open Market Committee meeting released this afternoon are essentially a look at policy through a rear-view mirror, we think they may still offer a foreshadowing of the FOMC consensus going into Jackson Hole later this week and into a pivotal September meeting.
*** We suspect the overall tone to the Minutes will read a bit more hawkish than certainly where the market expectations continue to be. Indeed, the reluctance of what was apparently a near majority of the Committee, including the dissents of two veteran, influential voters, was lodged against the rate cut itself, not just a more overtly market-friendly dovish messaging. Chairman Powell’s struggle to forge a more solid consensus in the meeting itself goes a long way to explaining the difficulties he had with the messaging misfire in the presser. ***
*** That said, however, as much as the market may have disliked the “mid-cycle adjustment” characterization of the July rate cut, the Minutes are likely to show it was in fact a pretty accurate description of where the FOMC consensus stood at the time. More to the point, however fumbled the messaging was in being a bit too clear – “constructive ambiguity” would seem to have its place at times – the Chairman’s July policy description is still a pretty accurate reflection of the Committee consensus going into the September meeting. ***
*** That means we still think July will be followed in September with another 25 bp cut, the second to a two-step reset of policy back below a consensus estimate of the short run r* near or just below 2.5%. With inertial inflation limiting upside costs, the reset is an “insurance” policy, modestly cushioning lower growth due to trade policy uncertainties and perhaps helping to stabilize inflation expectations. Crucially, it may also temper tail risk as an early start to what could still be an accumulative accommodation cycle if the data darken, or downside risk probabilities rise sharply. ***
A Long Arc of Accommodation
In hindsight, a “mid-cycle adjustment” may not have been the most optimal way to describe what has in fact been a long arc of accommodation since the pivot in Fed policy soon after December’s volatile market reaction to that rate hike and how it was framed. While it may seem a lifetime ago, the December rate hike marked the last leg of a four-year “policy normalization” strategy to bring the policy rate up to or near the best estimates at the time of the longer run neutral rate, to safeguard a “soft landing” in a potentially overheating economy.
US growth was expected to slow this year — after all, that was the point of pushing rates to or near neutral. But the economic forecasts and risks of below trend growth have been rising all through the first half of this year, largely on US trade policy taking a distinctly harsher turn in the negotiations with China, then compounded in May by the sudden turn towards renewed Mexico tariffs, only to be quickly rescinded.
May proved to be something of a game changer for many companies, large and small, as well as agricultural interests, judging by the anecdotal feedback in the district reports that went into the Fed’s Beige Book (see SGH 6/25/19, “Fed: Powell’s Message”).
Adapting to the modestly darker outlook amid so much uncertainty — which in the policy playbook more or less translates into hesitant spending, a lower short run r*, and more room for modest accommodation — the Fed’s policy pivot in the wake of a harsh market vote against the December policy messaging picked up in pace through the first half of this year to July’s rate cut, fully reflecting the newly adopted stance to “act as appropriate to sustain the expansion.”
But while much has changed since the July meeting rate cut, much of it bad — another escalation of tweeted trade threats and reversals after a plunging, highly volatile stock market, yields in near free-fall as capital fled for safety with a few more trillion dollars’ worth of negative yielding sovereign debt, to mention a few – the broader non-manufacturing US data has in fact continued to be fairly resilient, all things considered.
Indeed, the most recent retail sales and employment numbers would indicate how little the Fed’s base case forecast is likely to have changed since July. It is a point Federal Reserve Bank of Boston president, and July dissenter, Eric Rosengren noted in remarks on Monday.
Wider Confidence Bands
But what has changed since the July meeting, and by definition is unlikely be captured in the Minutes, is how much the confidence bands around the base case outlook have widened even further than they were in the March and June meeting Summary of Economic Projections and rate dot plots.
A high and still rising policy uncertainty – such as the on-off again payroll tax cut proposal this week, or the earlier higher tariffs against Chinese imports tweeted the day after the July meeting rate cut, then postponed till after the Christmas shopping season – still points to a further escalation of policy uncertainty, and with it, a further potential softening in US growth.
So even with data still showing only limited downside effects on broad-based aggregate demand, for a Committee majority, the rate decision becomes more than ever about judging risk probabilities rather than just a hard look at the story the data may be telling. It puts a relatively higher weighting on the arguments for a modest additional accommodation as insurance against the probabilities of a broader or deeper downward drift in growth below trend or worse that, if it proves needed, will cost little to take back at some point going forward.
The July Minutes are thus likely to reflect a discussion over these elevated risk assessments, and the outlook going into Jackson Hole and into September is likely to carry an even larger binary feel in the way the Fed staff make a best effort to model their projections against the backdrop of such abnormally wide confidence bands.
The downside uncertainties created by US trade policies is clearly dragging down business capital spending and slowing growth in the US and worldwide; but the larger US consumer sector remains fairly resilient, bolstered by a still strong labor market and even a modest increase in real wages.
Sifting for Signals Amid Noisy Data
For now, with the Committee’s more hawkish-leaning members still making the case there remains no clear sign of a broader weakening in economic momentum that would warrant additional accommodation, Fed staff will be especially sifting through the data in the coming weeks to for clearer evidence of “if, when, and to what extent” the business sector’s eroding lack of confidence and investment spending is spilling over into the far larger consumer side of the economy.
With that in mind, and taking the likely thrust of the cautionary July Minutes forward, the sharp drop in Friday’s Michigan confidence surveys may foreshadow a note of caution that may trump, if that is the right word, the reassuring data that suggest the economy is still resilient. That, in turn, we think is likely to translate into the case for modestly more accommodation going into the fall for a Committee majority in September — albeit with the accent on “modest” as the more hawkishly inclined FOMC members will caution that too much accommodation could spook consumers into thinking things are indeed getting as bad as the bond market is pricing.
The catch-22 of a more risk-management based policy path is that, invariably, data signals are rarely so clear, and when they are, it almost always means policy is too late and behind the proverbial curve. Monetary policy is always and everywhere a judgment call in that sense, and in the current politically-charged environment, it is even more so, with stakes as binary as the uncertainty that is making those judgment calls so immensely difficult to make.
Perhaps that is a challenge that will make it into what is surely going to be a long list of “Challenges to Monetary Policy,” the Jackson Hole conference theme and subject to Chairman Powell’s anxiously anticipated keynote address Friday morning.