A Friendly FOMC Meeting?

The stock market should continue to recover this week, even if the Fed cuts the funds rate by only 25 BPs.  This is because in addition to the rate cut it is very possible the Fed will signal more monetary policy easing in the rest of the year.   Moreover, the revisions to the Central Tendency Forecasts should be market positive.  And, there is a reason to think that the Fed's estimate of longer-run economic growth is too low, although it will not likely be changed at this meeting.  Putting aside specifics,  since the purpose of the easing would be to sustain solid economic growth, this policy background is an important positive for stocks.  

The Fed's signal of future rate cuts would be in the Central Tendency Forecasts and "dot" plots.  The latest Forecasts, made in June, showed the funds rate being cut to 4.9-5.4% by Q424, compared to the current range of 5.25-5.5%.  The updates will likely move this forecast down to 4.5-4.75% -- implying another 50-75 BPs in cuts over the two remaining FOMC Meetings this year.   The June "dot" plot put the median forecast at just above 5.0%.  This, too, is likely to move down to under 5.0%.

Updates to the economic components of the Central Tendency Forecasts should be stock-market positive:

1.  The forecast for Real GDP is likely to be raised to around the current upper estimate of 2.3%, as the H124 actual pace is 2.2% and the Atlanta Fed model estimate of Q324 is 2.5%.  The June range is 1.9-2.3%. 

2.  The Unemployment Rate forecast may be raised a bit.  In June, the forecast was for the Rate to be 4.0-4.1% in Q424.  It was 4.2% in August.  An upward revision could reflect expectations of increased labor force participation rather than weaker economic growth.

3.  The inflation forecasts could be lowered.  The June forecasts are 2.5-2.9% for Total PCE Deflator and 2.8-3.0% for Core PCE Deflator.  In July, the y/y was 2.5% for Total and 2.6% for Core.  They will move down more if they print less than 0.16% m/m from August through December.

Although the 1.7-2.0% estimate of the longer-run trend in Real GDP Growth is not likely to be changed at this meeting, this possibility may become an important focus either in the markets or at the Fed.  With US Population Growth at 1.2% and Nonfarm Productivity possibly continuing to exceed 1.0%, the longer-run trend in GDP could be in the 2.0-2.5% range.  A rising Unemployment Rate while Real GDP Growth is in the 1.7-2.0% range would suggest a higher range for the longer-run GDP trend than now estimated by the Fed.  If the Fed recognizes this, officials are likely to be more comfortable, if not more aggressive, in cutting rates.

On the data front, it is noteworthy that both Initial and Continuing Claims remained below their July average in the latest week.  It is possible that labor market weakness has bottomed.  Consensus looks for modest increases in August Retail Sales, both Total and Ex Auto.  This would still indicate a solid consumer after Sales jumped in July.