Will the Fed Do Enough This Week?

The Fed will probably bow to market expectations at this week's FOMC Meeting by opening the door a little wider for a near-term rate cut.  But, there is a risk officials will not widen the opening enough to satisfy market bulls.  The Statement should downshift its description of economic and job growth, which could be enough reason to cut.  To excite the markets, however, it might have to drop the word "patient" in describing monetary policy.  How officials handle this word or what substitute word they use will likely be the key to evaluating the Statement.

There is no question that the Statement's first sentence describing the economy has to downshift.  At the prior meeting in May it said;  "Information received since the Federal Open Market Committee met in March indicates that the labor market remains strong and that economic activity rose at a solid rate."  The overall description of the economy needs to acknowledge a slowdown in Q219.  But, if the Statement mentions the possibility the slowdown is temporary, then the implication for monetary policy will be muted.

Similarly, the Statement may downshift the second sentence regarding the labor market.   The prior Statement said, "Job gains have been solid, on average in recent months, and the unemployment rate has remained low." The comment regarding "solid" job gains probably should be modified, but not necessarily -- the sub-100k May Payroll gain could be chalked up to volatility.

In contrast to downshifting, the Statement would need to acknowledge a Q219 speedup in consumer spending in the opening paragraph rather than referring to the consumer slowdown in Q119 as did the prior Statement.  Note that the Fed staff predicted that a near-term slowdown in economic growth will be followed by stronger growth.  The question is how Fed officials will handle this outlook in their Statement.

The Statement should emphasize the continuing low inflation rate and subdued inflation expectations.  In particular, Friday's University of Michigan Consumer Sentiment Survey showed a drop to 2.2% in the 5-year inflation expectations measure, a new low (I believe) in this series.

Last week's US economic data did not resolve the question whether the Q219 slowdown will soon be over.  Overall manufacturing output was flat in May, after falling in April.  And, Initial and Continuing Claims have moved up somewhat. There is no sign in this evidence that the slowdown is ending.  But, there was positive economic evidence, too.  Motor Vehicle Assemblies rebounded sharply, suggesting the inventory correction in that industry is over.  And, Retail Sales sped up in May and were not as weak in April as the advance report said.  Consumer strength argues that a temporary factor, such as bad weather, was at least partly responsible for the economic slowdown.  It also shows that whatever caused the slowdown so far has not caused a snowballing downturn.

Even though the real-side data do not rule out the Fed staff's forecast of a temporary slowdown followed by a speedup in economic growth, the continuation of low inflation allows the Fed to move toward an easier stance.  While the Atlanta Fed model's projection has moved up to 2.1% for Q219 Real GDP, there seems to be more room for non-inflationary growth.  The possibility of 3% GDP Growth may very well be acceptable to Fed officials.