Can Powell take control of the doves tonight?

by Chris Becker

Fed Chairman Powell is testifying before Congress tonight AEDT on the state of the US economy and invariably, markets will hang on his words surrounding further interest rate cuts. At the moment, the probability of a cut at the July meeting remains at 100%, with a 94% chance of being lowered by 25 basis points.

The consensus view is he’s going to thwart the doves:

“If the Fed were to actively talk down July cut expectations, this would be the obvious time,” said analysts at RBC Capital Markets in a note. “But having passed up on opportunities to even hint that way in recent weeks, that seems less likely to happen.”

“Our best guess is that his testimony will highlight all the positives of the U.S. economy and when asked about cuts, Powell will repeat lines on using all available tools to extend the recovery.”

The reality however is that the Fed is caught captive within its own trap, beholden to provide a put to risk markets and provide an easing cycle to keep those precious stock bubbles afloat. Goldman Sachs are sticking their neck out by saying everything is fine, so why cut at all? Here are some of their reasons via ZH:

  • Fears of a sharp labor market slowdown have proven unfounded so far. Following the 224k rebound in June, both the 3- and 6-month averages for nonfarm payroll growth are now back above 170k.
  • While there has been a sharp slowdown in various manufacturing surveys, Goldman continues to believe that “much of this weakness reflects the ongoing inventory adjustment, which is likely to subtract 1.7pp from Q2 GDP growth” and adds that “we are now probably near the end of this process, as the level of inventory investment seems to have fallen to a below-trend pace and the economywide inventory/sales ratio appears to be peaking.”
  • The US Consumer has rarely been stronger: according to Goldman, prospects for final demand look good, as private domestic final sales probably grew almost 3% in Q2
  • Inflation is far from recessionary: while core PCE inflation remains at 1.6% year-on-year, significantly below the Fed’s 2% target, in Powell’s May 1 FOMC press conference, he characterized the weakness as “transient”
  • Trade war has taken a step back: with most dovish Fedspeak over the past several weeks emphasizing the increased uncertainty (especially with regard to trade policy) around a fairly optimistic central case as a reason for potential rate cuts, while the trade uncertainty has not gone away, the decision by Presidents Trump and Xi to return to the negotiating table and suspend the next tariff increase has reduced it, at least in the near term.

Each of these notes can be debated of course. Long term unemployment has bottomed with no slackness, just like before the start of every other recession in the last 50 years. Global manufacturing is in a slump, caused by the end of the business cycle and helped along by Brexit in Europe and the trade war in Asia. The US consumer is still borrowing heavily to fuel consumer spending, with credit at record highs and deliquincies catching up.

As for the trade war, even the White House’s terrible economic advisor pick is finally waking up to reality, Larry Kudlow stating in a CNBC overnight that “United States and China may never be able to reach a trade deal”.

The real pressure may be Trump wanting to follow his dictatorial friends by sacking their “independent” central bankers, as did Turkey’s Erdogan over the weekend, although Kudlow reckons “Powell’s job is safe for now”.

Be wary of those who completely missed the end of the business cycle last time to be cocksure everything is fine now.

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