Would a Fed Easing Be Appropriate?

The markets are boxing the Fed into a rate cut.  They assume the Fed will move to offset drags on the economy from tariffs, earlier monetary policy tightening and anything else.  Powell and other Fed officials have indicated the Fed will act if needed to sustain growth.  But, officials presumably need to see evidence that an economic slowdown will not end soon before doing so.  Many Street economists expect the Fed to bend toward easing at the June 18-19 FOMC Meeting and then follow through with a cut in July.  Whether Fed easing is appropriate could depend on the cause of slow growth.  Unfortunately, the appropriateness of a cut will probably be known only after it happens.

There are at least four reasons for the recent slowdown -- /1/ uncertainty among businesses regarding the impact of tariffs, /2/ drag on the consumer from higher prices stemming from tariffs, the earlier run-up in oil prices,  and shortfall in tax refunds,  /3/ bad weather, /4/ lagged impact of 2018 Fed tightening, /5/ dissipation of boost from 2017/18 fiscal stimulus.  Only the last two reasons truly justify a Fed easing.

Impact of Tariffs
A Fed easing will not necessarily be the correct offset to tariffs.  The threat to company profits from higher imported input costs -- either from a pass-through of the tariffs or the higher costs associated with shifting production from China to other countries -- will remain after an easing.  Instead, lower rates should boost commodity prices, hurting manufacturers and/or consumers.  This is what happened in 2008, when the Fed cut rates drastically in the mistaken belief that the problem was an illiquidity issue.  Rather, it was a confidence problem that lower rates did not address.  The jump in oil prices, in particular, was a factor pushing the consumer off a cliff back then.

Drag on Consumer
The recent drags on consumer spending should be temporary and not prompt a Fed easing.

While the tariffs lifted the targeted goods' prices, they also resulted in a stronger US dollar -- reflecting an expected narrowing in the trade deficit.  The stronger dollar not only offset some of the direct price hikes from the tariffs but lowered the prices of non-targeted import prices.  The low inflation prints seen since late last year appear to confirm that the net effect of the tariffs is to lower inflation. 

The drag from higher oil prices and shortfall in tax refunds also are behind us.  Oil prices have retraced most of their earlier advance.  And, the issuance of tax refunds is largely over.  They now are less of a factor impeding consumer spending.

Bad Weather
Bad weather in the Midwest hurt construction spending in May, according to comments collected in the Non-Mfg ISM survey.  There should be catch-up over June and July.

Lagged Impact of 2018 Fed Tightening
At the minimum, the Fed tightening over 2018 was overdone.  Arguably, it was unnecessary, based on the absence of higher inflation.  Nonetheless, monetary policy tightening affects the economy with a lag.  The continuing sluggish housing activity -- the most interest-sensitive sector -- attests to the possibility that last year's tightening is still having an effect (as well as the bad weather).  A Fed easing to unwind last year's tightening would seem to be appropriate.

Dissipation of 2017/18 Fiscal Stimulus
Most models predicted that the economic boost from the 2017 tax cut and 2018 Federal Government spending increase would begin to unwind in 2019.  To be sure, some of the unwinding was expected to be caused by higher interest rates.  So, to some extent this reason is "double counting" the 2018 Fed tightening reason.  It is still a reason to justify Fed easing.

This Week's US Economic Data
Some of these ideas could be reflected in this week's US economic data.   May Retail Sales should strengthen from April's low pace.  Ex Auto Retail Sales may very well exceed the +0.3% m/m consensus (after +0.1% in April) -- as the temporary drags wear off.  May core inflation should be benign, with the Core CPI possibly slower than the +0.2% m/m consensus -- held down in part by the stronger dollar.   Anecdotally, airlines and phone companies are said to have engaged in price wars this month.  May Industrial Production, particularly manufacturing output, should be sluggish -- in part dissipation of fiscal stimulus.   Consensus looks for a slight +0.1% m/m for both.