FOMC Watch - Growth moderates, inflation picks up, Fed on hold
Yesterday, the Fed kept its rates on hold, in line with broad expectations. The press release noted that both inflation and uncertainty remained elevated. It described growth as having moderated, potentially a dovish nod to the two dissenters, Christopher Waller and Michelle Bowman, who preferred to cut rates this meeting. We've previously written about public calls for cuts by these two Trump-appointed board members, and continue to see the statements as largely political, with Waller in contention for the Chair position next year. June's dot plot made it clear there were two other groups; a first camp that expects mild inflation impact or a further deterioration of the labour market, allowing for, or even requiring, two potential cuts this year, and a second camp that expects rates to stay on hold for the remainder of the year. The overall moderately hawkish press conference may suggest that the second camp is growing in size.
Throughout the press conference, Powell made it clear that he does not rule out a September cut, but that incoming data and fiscal policy developments will ultimately determine monetary policy. He noted that the majority of the committee thinks a modestly restrictive policy is appropriate right now, and moreover, that the economy is not really performing as if policy is restrictive. Information about the outlook in light of tariffs is gradually revealing itself, and that he expects 'there's much more to come as well, looking ahead.' In a surprisingly hawkish statement, he argued that the fact that they are not raising rates in response to rising inflation shows the Fed is currently looking through the potential price effects, explaining that a reasonable base case for the tariffs would be a one-off price shock.
Risks to the economic outlook remain, but do not yet call for action
GDP growth for Q2 surprised to the upside at 3.0% annualized. The high figure was largely due to a 5pp contribution from net exports, with imports declining substantially after the frontloading in the first quarter. It is therefore better to look at the combined figures over the first half year, which shows 1.3% annualized growth, down from 2.8% last year. Importantly, private demand (final sales to domestic purchasers), which strips out the volatile trade and inventory components as well as government spending, decreased from 1.9% to 1.2% annualized between Q1 and Q2, showing a trend towards the economy slowing down. We expect this slowdown to continue over the course of the second half of the year on the back of economic uncertainty and direct impact from the tariffs.
Powell noted that the labour market is still broadly in balance and close to maximum employment, while downside risks are certainly apparent. In assessing the labour market, he deems the main figure to be the unemployment rate, which, due to both decreasing demand (Powell: 'lower payroll figures') and decreasing supply (ABN: due to immigration restrictions), remains 'in balance.' We actually expect a relatively strong non-farm payroll reading later this week, with unemployment ticking back up to 4.2%. This is still a low figure, and we only expect a modest increase over the course of this year, providing no reason for the Fed to step in.
As for inflation, Powell pointed out the shift from services to goods inflation, with the former having eased, and the latter showing an acceleration due to tariffs. There are many uncertainties to resolve - the Fed is learning more and more - but he expects more inflation to show up. The official release of the quarterly figure, which was available at the time of the decision, suggested a 0.5% m/m core reading for June in the absence of revisions. Now, the day after the press conference, the figure came in at 0.3% m/m, but the y/y rate surprised to the upside by remaining at 2.8%. These further price increases were accompanied by only modest gains in real personal spending, suggesting a large supply/tariff component. We continue to expect that inflation will pick up further over the coming months.
Overall, the July FOMC meeting largely reflected an FOMC which is slowly but surely edging towards our base case of no cuts this year. While we had put Powell firmly in the two-cuts-camp in the last meeting, he now seemed to be a bit more hawkish. Ultimately, the trajectory will crucially depend on the two inflation and labour market readings before the next meeting. They are unlikely to be a call for action, implying that the Fed will prefer to remain 'well-positioned' to react if and when the data calls or allows for it