Tim Duy brings us his latest Fed Watch:
It appears that a 25bp rate hike is in the cards this week – a widely accepted view on the outcome of the two-day Fed meeting, as revealed in the market for fed funds futures via macroblog. So the interesting question is "What comes next?" I believe that the Fed remains not quite ready to signal the end to rate increases, as they tend to view US growth as fundamentally solid. Consequently, I also expect them to retain language describing policy as "accommodative." That said, the Fed will likely tone down its assessment of the economy to acknowledge the lackluster flow of data from since their last meeting. The tone of the data also calls for retention of the measured pace language.
It is notable that Fedspeak, with the exception of Dallas Fed President Richard Fisher’s errant comments, has tended to be supportive of further rate hikes. For example, Mark Thoma referenced John Berry’s piece last week regarding interviews with Minneapolis Fed President Gary Stern and Richmond Fed President Jeffrey Lacker, neither of whom sounded ready to shift from the Fed’s path of measured rate increases. Two week’s ago, Kansas City Fed President Thomas Hoenig indicated that the neutral range for the Fed Funds rates is 3.5-4.5%. Of course, this is not terribly surprising; I have trouble imagining a central banker describing the current situation of near zero real short term rates as anything other than accommodative.
Last but most importantly, Fed Chairman Alan Greenspan’s testimony on June 9 gives no indication that he is ready to dramatically alter his take on economic activity. Note that Greenspan’s comments came after the disappointing ISM and employment reports. A few choice quotes:
"The most recent data support the view that the soft readings on the economy observed in the early spring were not presaging a more-serious slowdown in the pace of activity. Consumer spending firmed again, and indicators of business investment became somewhat more upbeat."
"The alternating bouts of rising and falling oil prices have doubtless been a significant contributor to the periods of deceleration and acceleration of U.S. economic activity over the past year."
"Despite the uneven character of the expansion over the past year, the U.S. economy has done well, on net, by most measures."
"Accordingly, the Federal Open Market Committee in its May meeting reaffirmed that it ... believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability."
Has much changed since Greenpan’s comments? Manufacturing activity has been mixed, with industrial production up and headline durable goods orders both up, the latter on the back of fresh Boeing orders, but nondefence, noaircraft capital goods down. The housing market continues to hold, with new sales up. Inflation figures were tame, as measured by the PPI and the CPI. Leading indicators were down, as were retail sales. And anecdotal evidence, as measure by the Beige Book, is consistent with these data snippets.
Reports from all twelve Federal Reserve Districts indicate that business activity continued to expand from mid-April through May. Most Districts--including New York, Richmond, Atlanta, Chicago, Minnesota, Kansas City, and San Francisco--characterized the pace of expansion as moderate, solid, or well-sustained. However, Philadelphia noted that the pace of growth had eased in May while Boston and Cleveland observed some unevenness across sectors.
Reports on retail sales in April and May were mixed.
Reports on residential real estate markets remained quite positive overall, although some slowing in activity was noted in a few markets.
Labor market conditions continued to improve in most Districts, and several reports cited difficulty finding specific types of workers.
Most Districts reported that manufacturing activity continued to expand, although several Districts noted that production had slowed or leveled off.
Overall, I would describe the incoming data as lackluster, and I believe the FOMC will as well. Nothing spectacular, nothing disastrous. Most notable is the rise in oil prices to record highs since the last FOMC meeting, an event that will likely cut both ways for the FOMC. Higher oil will likely cause a slowdown in the pace of activity (as noted by Greenspan above and macroblog here), but also implies incipient inflationary pressures.
So what’s the bottom line? Stay the course, remain confident about overall economic activity, but acknowledge the risks to the outlook. Or, in other words, hike rates and reduce accommodation at a moderate pace. Overall, I think the Fed will try to impart the feeling that while they are aware of the downside risks to the outlook, markets should expect additional rate hikes later this year.
[Note: Sorry for my absence from Mark’s blog – I tend to ease back for a few weeks after the school year comes to the close. Plus, it is a good opportunity to spend some time with our littlest economist at home.]