Beyond the September FOMC Meeting

The markets are likely to be little affected by this week's FOMC Meeting. Stocks should continue to rally and Treasuries remain range bound.  The meeting's outcome should match expectations of no rate hike but commencement of balance sheet reduction.  And, the Statement does not have to change much from July's, except perhaps for some acknowledgement of the temporary drag on the economy from the recent hurricanes.  With the Statement likely to keep in place the idea of gradual tightening, the market focus will shift further to the possibility of a Fed rate hike at the December FOMC Meeting.  Upcoming wage/price inflation data, however, will probably not make a persuasive case for tightening then.

The combination of no rate hike and balance sheet reduction can be viewed as a compromise between the doves and hawks on the FOMC.  A dovish victory would probably require a change in the Statement along the lines of Fed Governor Brainard's views.  The Statement would say that the Fed plans to hold back from tightening until it is clear that inflation has moved above 2.0%.  This would be a big positive for stocks and result in a steeper Treasury yield curve, helping TIPS in particular.

Even if the doves do not get their way, upcoming wage/price inflation data may very well keep the Fed on hold in December, as well.  Although Friday's August Core CPI rose 0.2% m/m, some of the pickup was in rent, which has a smaller weight in the PCE Deflator.  So, a 0.1% m/m print for the August Core PCE Deflator cannot be ruled out.  It would keep the y/y steady at 1.4%.   The Core PCE Deflator needs to average 0.1% per month for the rest of the year to keep the y/y at 1.4% in December.   As for Average Hourly Earnings, calendar considerations point to 0.2-0.3% in September (next report), but this would keep the y/y steady at 2.5%.  AHE should slow to 0.1-0.2% m/m in October and November.  The y/y would fluctuate between 2.4% and 2.5%.