Today's two important reports -- Q217 Real GDP and Employment Cost Index -- confirm the continuation of moderate economic growth with little inflationary pressures. They are not likely to change officials' views -- both dovish and hawkish -- within the Fed. But, if this combination continues in upcoming July-August data, it is conceivable that the Fed could keep the funds rate steady but commence balance sheet reduction at the September FOMC meeting (possibly hinted at in this week's FOMC Statement that "the Committee expects to begin implementing its balance sheet normalization program relatively soon.")
The 2.6% Q217 Real GDP showed the expected bounce-back from the soft 1.2% Q117 pace (revised down from 1.4%). Economic growth in H117 was 1.9% -- about the same as the 1.8% 2016 growth rate (Q4/Q4) and in line with the Fed's longer-run 1.8-2.0% central tendency. The most interesting components of Q217 GDP were the further strong showing of Business Fixed Investment (2nd strong quarter in a row and possibly helped by pro-growth attitude of the Trump Administration) and another quarter of negligible Inventory Investment (possibly reflecting the shift away from brick and mortar retailing -- a stealth factor holding down economic growth). In addition, the underlying inflation measures were very soft, particularly with the Core PCE Deflator slowing to 0.9% (q/q, saar) and the Market-Based Core PCE Deflator to 0.2%.
The absence of inflationary pressures was evident in the Q217 Employment Cost Index, as well. The ECI slowed to 0.5% (q/q) from 0.8% in Q117 -- even excluding jobs with a commission component (0.5% from 0.9%). The y/y was steady at a moderate 2.4%.
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