A 25 BP Fed Rate Cut, More To Come?

The stock market rally should be sustained by this week's FOMC Meeting.  Besides a 25 BP rate cut, the Statement or, more likely, Fed Chair Powell could signal that more easing will be coming if needed.  And, this week's US economic data are expected to keep that possibility alive by underscoring a sluggish growth pace.

A Fed easing path will likely embody a number of 25 BP rate cuts.  There are several reasons to expect such a cautious path.  First, inflation remains higher than target, with the culprits including more than just tariffs.  In particular, housing rent (primary and owners' equivalent rent) continue to run 0.3-0.4% m/m.  It likely needs to slow to 0.2% in order for the Fed to hit its 2% inflation target.

And, tariffs remain a problem for the inflation fight, although there were some signs of a moderation in their impact in the August CPI.  A jump in Food Prices At Home in August may have been caused in part by tariffs.  The unusually large 0.6% in these prices most certainly is a factor behind the depressed level of consumer confidence.  In contrast, Household Furnishings and Recreational Commodities flattened out after a couple of months of large increases, suggesting the impact of tariffs on them is settling down, in line with the Fed's best guess that the tariffs will have a one-off impact on inflation. 

Nevertheless, the Fed may be concerned by signs that longer-run inflation expectations have ratcheted up.  The University of Michigan Consumer Sentiment Survey shows 5-year inflation expectations at 3.9%, well above the 3.0-3.2% range seen before the start of tariffs.  

As a result, allowing a somewhat softer labor market for a while may be optimal monetary policy in the context of tariffs.  It would prevent a wage-price spiral from developing by dissuading labor from bargaining for higher wages to offset the loss of purchasing power.  The Fed would never admit to this reason.  However, Powell acknowledges that wage inflation has not been a source of inflationary pressure, showing that Fed officials are cognizant of this potential.

A sluggish pace of economic growth is expected to be apparent in this week's US economic data releases.  Consensus looks for a slowdown in Retail Sales to 0.3% m/m in August from 0.5% in July.  Ex Auto Sales are seen repeating July's modest 0.3% increase.  This gain is even smaller in real terms, that is once inflation is taken into account.  Consensus sees flat August Industrial Production after -0.1% in July.  There is downside risk from a likely decline in Manufacturing Output after a flat July.   Consensus expects little m/m change in August Housing Starts and Permits.