A Fed Rate Cut and Upcoming US Economic Data

This week, the markets will be focusing on the July 30-31 FOMC Meeting and key US economic data -- July Mfg ISM and Employment Report.  With almost everyone expecting a 25 BP Fed rate cut, the issue will be the extent to which officials keep open the door for additional easing.  The strength or weakness in this week's key data will influence market expectations regarding future Fed moves.

FOMC Meeting
The Fed is almost certain to follow through with a 25 BP rate cut at this week's FOMC Meeting, given Powell's prior comments regarding downside risks.  But, as Friday's Q219 GDP Report and other recent data show, there is no compelling reason for the Fed to do so.  At 2.1%, Q219 Real GDP Growth was above the longer-run potential pace, despite hits from bad weather and Boeing production cutbacks.  Nevertheless, the Statement will likely keep open the door for additional cuts by promising to "act appropriately to sustain the expansion."

From a market perspective, the issue will be whether the downside risks concerning the Fed will continue.  In a recent speech, Fed Chair Powell enumerated the "downside risks" to the outlook.  He mentioned trade developments, global growth, the US federal debt ceiling and Brexit.  Some have either disappeared, such as the Federal debt ceiling, or pushed further ahead, such as trade developments.  And, most US economic data have strengthened in June-July.  But, weaker global economic growth remains, as seen in the further declines in Flash July European PMIs.  While the stronger US economic data makes justification of a rate cut difficult, the Fed could still emphasize the weaker global growth as a downside risk to the outlook.

An academic idea that is popping up in Fedspeak is the desirability to move in anticipation of economic weakness when the funds rate is close to zero.  By doing so, monetary policy could prevent the weakness from happening and thus the funds rate from moving to zero.  This notion provides a motivation for the Fed to act on its perceived downside risks.  A question arises whether the Fed will tighten quickly if economic growth turns out to be stronger than expected or if inflation accelerates to above 2.0%.  If it does, Fed policy could appear fickle, based on faulty forecasts.  This perception could damage its credibility and create uncertainty/volatility in the markets -- which could negatively influence economic activity.

Economic Data
This week's key US economic data risk adding to doubts about the likelihood of further rate cuts this year.  In particular, Mfg ISM and July Payrolls could surprise to the upside.

Evidence is mixed with regard to the July Mfg ISM.  Richmond Fed Mfg and Markit Mfg PMI fell this month, but the Phil Fed Mfg Index rose.  None has a good tracking record with the Mfg ISM.  Consensus is for an increase to 52.0 from 51.7 in June.  I lean toward an increase, as well, as the June dip did not pick up the improvement seen in manufacturing-related data for that month.  To be sure, the Mfg ISM would need to rebound to above the 52.2 Q219 average to hint that manufacturing malaise is ending.  A rebound above the 55.3 Q119 average would say that the malaise is over.

July Nonfarm Payrolls risk printing above the +165k m/m consensus, based on the Claims data.   It even could be stronger than June's +224k.  The Q219 average is 171k, while the H119 average is 174k.

Average Hourly Earnings risk printing a low 0.1% m/m, thanks to calendar considerations.  The y/y would be 3.0-3.1% (depending on rounding), versus 3.1% in June.  Consensus is 0.2% m/m and  3.1% y/y.