The FOMC concluded their monetary policy meeting today, which, as expected, resulted in no change to the fed funds rate—currently targeted to a range of 1.75-2.00%. There were no dissenting votes.
The formal narrative again was positive in its assessment of overall conditions, with both economic activity and labor market descriptions being upgraded from ‘solid’ to ‘strong’. As we’ve noted before, the FOMC statements have taken a decidedly more direct and business-like tone with Jerome Powell as chair, as opposed to the longer and more detailed releases under the Janet Yellen regime. The movement away from the quantitative easing program, and various nuances with ‘tapering’, has also helped. The periodic Q&A sessions (next scheduled for September) have been similarly more direct and in more straightforward language, which is not surprising considering the more diverse background of the current Fed chair compared the previous few, who originated from academia prior their tenures in the Federal Reserve system.
The committee has been on a pace of raising the fed funds once per quarter. The consensus view expects the FOMC to continue on this trajectory, with a 90% probability of a 0.25% hike at the September meeting. The odds for a fourth hike this year in December have grown from 50-50 a few months ago to more like two-thirds today. Based on what we know now, based on the current level of economic growth as well as strength in labor and inflation, 2019 could look similar to 2018 with 3-4 increases projected. However, that remains a long time away, with some of the impact from the recent tax cuts waning a bit by then, and such a pace will no doubt depend on continued strength in the Fed’s key metrics outlined below.
Economic growth: Last week, advance GDP results for the 2nd quarter showed growth of 4.1%. This was close to the median expectation, although estimates beforehand varied a bit more at the extremes than usual (ranging anywhere from the mid-3’s to low-5’s). Consumer spending and business expenditures were both stronger than anticipated, and any negative sentiment due to recent trade/tariff concerns does not appear to have filtered through thus far. In fact, it represented the strongest quarter in several years, and while it could be difficult to keep up this same high-growth trajectory, anything close could keep the pressure on the Fed to continue tapping on the brakes by raising rates. In theory, it’s always preferable to keep economic overheating to a minimum, as opposed to the more difficult job of clean-up after the fact, as the last decade can attest.
Inflation: In June, on a trailing 12-month basis, CPI increased to 2.9% on a headline level and 2.3% for core, after removing the impact of food and energy. There has been sporadic jitteriness by some investors in a continual search for the ‘missing’ inflation that was assumed to be around the corner after years of stimulus, and more recently, with high economic and earnings growth rates. But the picture remains mixed. Wage inflation, that was assumed to be waiting right behind labor markets reaching multi-decade tight levels, hasn’t yet manifested. While the Fed described inflation as remaining near target with longer-term expectations unchanged, the trend of inflation is the one area of policy that could cause the Fed to reconsider rate hikes at this current pace.
Employment: Few changes have occurred here in recent months, other than unemployment continuing to appear very solid, at levels near or better/lower than that of what economists call ‘full employment’. Additionally, jobless claims, JOLTs and other data show low levels of layoff activity. The multi-decade strength in labor markets represents another component that would push the Fed toward keeping rate hikes moving ahead.
Investment market results have been mixed this year, with substantial improvements in fundamentals and positive tax reform effects already ‘baked’ into prices beforehand, so to speak, with markets acting in their typical manner of constantly searching for what lies ahead (as opposed to what’s already happened). This has been coupled with the wildcards of trade/tariff uncertainty, elections abroad and concerns over the sustainability of global growth—both of which have weighed on foreign stock and bond markets especially. The sustainability of this stage of the business cycle appears top of mind, as conditions now appear strong enough that it could be hard to generate continued improvements. This is typical, and not the worst thing in the world from an economic or near-term investment standpoint, but, based on history, could limit outsized return potential on a forward-looking basis.