From Elliott Clarke at Westpac:
The July FOMC meeting minutes were not as conclusive on a September first hike as we or the market had hoped. Indeed, while they “continued to see the risks to the outlook for economic activity and the labor market as nearly balanced”, there is obviously a great deal of apprehension about making the first move in the rate normalisation process – nigh on a decade after the last rate hike.
For the FOMC, their concerns do not rest with aggregate activity. Incoming partial data was broadly seen as “confirming their earlier assessment that the weak report on real GDP in the first quarter reflected transitory factors and [they] expected that real economic activity would continue to expand at a moderate pace”. On the back of this belief, there was an expectation that an “improvement in labour market conditions” would be seen, further reducing labour market underutilisation.
For policy, of particular note in the minutes was that not only did most “members [see] room for some additional progress in reducing labor market slack”, but many “members thought that labor market underutilization would be largely eliminated in the near term if economic activity evolved as they expected”. That is full employment of ‘available’ labour market resources (i.e. those seeking to participate) is drawing near.
As such, they remained positive on the outlook for the consumer, the driving force behind aggregate activity; more constructive on housing; and hopeful with respect to business investment.
Where the questions begin for the FOMC is in the link between labour market slack and wages and the implications for inflation. While there was some discussion of growing competition amongst firms for labour market resources, on the whole, it was clear that aggregate wage outcomes continued to disappoint. Indeed, the FOMC even went out of their way to dismiss the strength in the Q1 Employment Cost Index, which was subsequently followed by a weak outcome for Q2 (after the July FOMC meeting).
Given the uncertainty surrounding the linkages between activity and inflation, “almost all members indicat[ed] that they would need to see more evidence that economic growth was sufficiently strong and labor markets conditions had firmed enough for them to feel reasonably confident that inflation would return to the Committee’s longer-run objective over the medium term”.
Two points from the above position need to be highlighted.(1) The July meeting was followed by an upward revision to Q1 GDP, a solid Q2 GDP print, and continued robust job gains with the unemployment rate near full-employment. Hence, in the intermeeting period we have seen “more evidence” in favour of stronger growth and tighter labour markets. (2) It is also important to recognise that the 2.0% inflation target is a “medium term” concern. Belief that it can be achieved in the future is enough to begin the normalisation process. At present, both the Fed staff and FOMC participants still believe that inflation will tend towards 2.0% over the next few years.
Overall, financial markets continue to hedge their bets over a September move, but we remain of the view that it will occur. Further, we also believe a follow-up move will be delivered with but a short delay. For us, where the risks to the rates outlook lay is further out – after the Fed Funds Rate is no longer wedded to the lower bound. At that point, weak inflation (should it persist) will become a much bigger concern in the absence of transitory factors, one that could likely be met with a period of ‘on hold’ rates awaiting further information.
No way, Jose. Oil, my friend. Its affects may be transitory but they matter. BNP has it right:
The Committee is increasingly convinced that the labour market is near or very close to where it needs to be to justify liftoff, but not confident on the inflation outlook. The subsequent Chinese devaluation and weak commodity prices will not have helped the Committee’s confidence in their inflation outlook.
The minutes reinforce our own confidence in a December rate hike, with September looking a long shot with only a 10% to 20% chance. The Fed’s discussion of reinvestment policy in July supports our long-held view that it will be sensible to smooth out the balance sheet run-off.
