This Friday’s Non-Farm Payroll smack in the middle of the Fourth of July long weekend and the next slew of inflation and inflation expectations measures promise to be key signposts on the way to the Federal Open Market Committee rate decision at their meeting at the end of this month.
*** We find little sense of a consensus taking shape for a 50 basis point cut at the July 30-31 FOMC meeting, and more of a resignation rather than conviction driving the Committee to a likely 25bp rate cut. That suggests the run of data will play a larger than normal role in tipping the scales on the rate decision and how to frame it: it is fair to say a surprisingly weak NFP would firm the rate cut case and could even open the door to the more aggressive 50bp cut if other data indicated a faster than expected slowing in growth or inflation expectations, and the latter, in fact, may still prove as decisive to shaping the July consensus as signs of weakening growth. ***
*** While consumers look to be holding in, Fed districts are anecdotally reporting deepening declines in business confidence and investment plans that threaten a trade war drag on growth. It gives the economy a downside burdened, binary feel, against which rate cuts offer limited relief to the real economy but potentially stoke financial excesses. Unless this month’s data provide a clearer picture on the outlook, September rather than July may prove to be the more pivotal meeting to determining whether rate cuts are the start to a deeper easing cycle, or a two step “insurance” rate reset that would bring policy back to an “in either direction” stance. ***
*** The new “act as appropriate” messaging is an older generation’s “high pressure economy” to lift labor participation and wages and, ideally, inflation expectations. But the FOMC still seems reluctant to embrace a more aggressive reaction function, preferring instead a longer run of data cover, if for nothing else, to provide a credibility shield against political pressure. In other words, the case for an “ounce of prevention” or to preemptively counter faltering inflation expectations still needs to be made. But there is a keen eye on the coming inflation measures, for another drop in expectations could still make just that case for a more aggressive cut in time for July if certainly September. ***
May’s Trade War “Game Changer”
The G20 trade talks truce between Presidents Trump and Xi pretty much came out as expected by most Fed officials, which is why Chairman Powell had cautioned at the June FOMC meeting presser the Fed would not be “exclusively focused on one event” in the “closely monitoring” stance in the run up to the July meeting.
But the trade headwinds nevertheless continue to drag on US and global growth. Earlier anecdotal evidence of falling business confidence and hesitation on slowing investment plans across almost all of the Fed’s 12 districts has now begun to show up in recent manufacturing sector data. In particular, Fed staff found that the May escalation in the trade threats against China, even if now on hold, and especially the sudden tariff threat, also reversed, against Mexico was a “game changer” for many manufacturers in putting a hard stop to investment plans until a clearer picture emerges on trade rules and global demand.
A longer, lingering arc of trade tensions and uncertainties that will continue to drag on the supply side of business confidence and capital spending was written into the June meeting projections, and will continue to be in July and September. What’s more, the drag may only increase in the months ahead as recent presidential tweets are still threatening tariff escalations against the European Union, Japan, and India, while the new USMCA is still pending a congressional vote.
In effect, the trade wars are having a faster and deeper impact in slowing growth than the slower transmission of the rate increases through last year that were intended to foster an economic “soft landing.” While the trade effects cut both ways, and could in time foster a stagflation-like feel to prices, the Fed is for now giving greater weight to the faltering growth and the risk it could spread to the consumer side.
These trade-driven headwinds may color the takeaways from Wednesday’s non-manufacturing ISM numbers and especially Friday’s NFP breakdown. We gather that the Fed’s own base case NFP expectations is for a jobs creation number not too far above last month’s 75,000 print, which the market took to be a far weaker signal than the Fed did.
But it is not so much that a weakening jobs number would alter the forecast all that much by the time of the July meeting, but that it may sway the mood and messaging in the run up to July. If the market seizes on a weak NFP number, Chairman Powell would have to use his July 10 Humphrey Harkin testimony to make a concerted push back, if the Fed had any real problems with the market pricing, which, so far, it has not.
A stronger than expected print, on the other hand, would probably not alter the FOMC’s internal lean towards a rate cut in July, though the case will have to be more convincingly made, perhaps on the grounds of faltering inflation expectations if that proves to be the case.
A Limited Rate Cut Impact on the Real Economy
Indeed, the economy overall is not doing all that badly, at least so far, unless the business caution translates into outright worker lay-offs and flattening wage growth that would finally derail retail spending and aggregate demand. But so far, US households are in fact boosting not trimming their spending, on the back of decent real income growth.
And the economic expansion, today crossing into record length, has been so slow and so gradual in coming that it has been hard for excesses to build in inventories or housing, or in strained capacity. Indeed, the only early signs are not real economy but financial market excesses, both in the fixed income market’s penchant for recession pricing and the stock market’s relentless momentum towards euphoric heights.
That is drawing caution among some FOMC members that a rate cut will have at best a limited impact on the real economy when it is trade and oil-sanction policy driving the slowing growth rather than the cost of capital or financial conditions that are as easy as they were prior to last October and December.
But, for now, most Fed officials reckon a defensive rate cut would do little harm since there is such a near total absence of upside inflation risk, and may in fact help to cushion business and consumer sentiment by showing the Fed is on guard to “act as appropriate” if growth threatens to drift below the estimated median 1.9% trend or worse.
The Committee, then, still looks near certain to stick to their signaling a rate cut in July that is more likely than not. Only a surprising turn north in the data over the coming weeks would alter that expectation and potentially color the messaging in the days before the pre-July meeting blackout in three weeks.