The Last Large Fed Rate HIke?

The stock market looks like it could be looking past the likelihood of a 75 BP hike at the September 20-21 FOMC Meeting, expecting it to be followed by a downshift at the next meeting.  A downshift to 50 BPs after the September meeting is conceivable, as evidence of a slowing economy and continuing pass-through of lower energy prices builds.  But, it's not a foregone conclusion.  This week's US economic data, nevertheless, should encourage this expectation.  

A 75 BP hike at the September FOMC Meeting is still the best bet.  Fed Vice Chair Brainard laid out the reasoning in a speech last week.  She acknowledged the recent decline in commodity prices and the low July CPI.  But, she needs these favorable developments to be sustained to convince her that inflation is being brought under control.  She said, "While the moderation in monthly inflation is welcome, it will be necessary to see several months of low monthly inflation readings to be confident that inflation is moving back down to 2 percent....How long it takes to move inflation down to 2 percent will depend on a combination of continued easing in supply constraints, slower demand growth, and lower markups, against the backdrop of anchored expectations."  These will take time to achieve.  And, she warned that "if history is any guide, it is important to avoid the risk of pulling back too soon."  So, even if the Fed  downshifts after the upcoming meeting, further rate hikes would seem to be likely.

This week's US economic data are expected to be in line with Brainard's prescription for bringing down inflation.  Consensus looks for -0.1% m/m Total and +0.3% Core for the August CPI.  And, the risks are to the downside for both.  Consensus also expects 0.0% m/m for both Total and Ex Auto August Retail Sales.  The drop in gasoline prices is behind both low estimates.  Once again it will be more important to see the Ex Auto/Ex Gasoline Sales print to get a sense of consumer spending.  It has been trending +0.7% m/m over the past few months.  Two manufacturing surveys are expected to be soft this week.   The September Phil Fed Mfg Index is seen falling to 3.5 from 6.2, while the NY Empire State Mfg Index is seen remaining weak at -15.25 after -31.3 in July. 

Brainard commented on the dichotomy between the strong job growth and weak GDP growth.  (The Atlanta Fed model lowered its estimate of Q322 Real GDP Growth to 1.3%.)  She said,"Labor demand continues to exhibit considerable strength, which is hard to reconcile with the more downbeat tone of activity.  Year-to-date through August, payroll employment has increased by about 3-1/2 million jobs, a surprisingly strong increase given the decelerating spending and declining GDP over the first half of the year."  I continue to believe that the dichotomy can be explained as a difference between the level of and rate of change in demand.  Jobs have been catching up to a high level of demand, while demand is slowing.  The dichotomy may be changing.  The latest Claims data suggest that companies may be finally pulling back on hiring.  A further slowdown in Payroll growth can't be ruled out at this point.