Will the Fed Skip September?

Some market economists are raising the possibility that this Wednesday's widely expected Fed rate hike will not be followed by another hike at the September FOMC Meeting.  Some cite the possibility of a federal government shutdown in August if the debt ceiling is not raised.   Others point to the absence of an acceleration in wage/price inflation, in line with the most recent comment by the dovish Fed Governor Brainard.  Another risk that would argue against a September rate hike is a renewed slowing in economic activity.  All three risks are positives for Treasury prices but negatives for stocks and the dollar.

The ECRI Leading Indicator, indeed, points to slower GDP growth ahead.  It has been on a flat to slightly down trend since February.   A slowdown could be modest, however, as Financial Market Conditions remain accommodative.  The NY Fed's model projects GDP to slow to 1.8% in Q317 from 2.3% in Q217.  The Atlanta Fed's model is now down to 3.0% for Q217 GDP Growth, suggesting that some of the forces behind a slowdown are already coming into play -- weak April Wholesale Inventories accounted for some of the downward revision to the Atlanta Fed's projection (see below).

ECRI Leading Index (level)
 

The latest Claims data hint at a softening in the labor market.  Initial Claims averaged  250k in the past two reports, putting them in the upper end of this year's range.   To be sure, the latest report was for a week that contained a holiday (Memorial Day), so it could have been distorted by difficult seasonal adjustment.  It will be important to see if Initial Claims stay high in this Thursday's report.  It also will be important to see if Continuing Claims begin to move up, as well.

                          Initial Claims (level, 000s)
       Latest 2 Weeks                     250
       May Avg                              240
       Apr Avg                                241
       Q117 Avg                             243
       Q416 Avg                             256

The shift toward on-line shopping could be a significant factor behind a slowdown in GDP Growth -- an unusual reason for a slowdown.  Consumption could be hurt through less "impulse" buying and ancillary buying, eg, at restaurants situated near stores.  Also, the decline in retail jobs will hold down income growth.  Even if consumption is unaffected by the shift, the latter could reduce the amount of inventory as retail stores close.  Besides the unwinding of the stock of goods at these stores, there could be a reduction in the inventory-sales ratio.  In other words, warehousing inventory could lead to efficiencies, as less inventory per dollar of sales is needed.  Business Inventory Investment would fall or stay low, thereby holding down GDP Growth.  Note that higher short-term interest rates also could hurt inventory investment, since inventories tend to be financed short-term.  So, the Fed tightening would be partly responsible for a slowdown in inventory investment. 

Note that Wednesday's FOMC Statement accompanying will probably be backward looking, just as was the May FOMC Statement.  It should cite a speedup in economic growth this Spring, while the May Statement pointed to slow growth in Q117.