Fed Leading From Behind?

The stock market will be entering a period of seasonal volatility and weakness in August and September with little guidance from the Fed.  Fed Chair Warsh appears content to let the markets decide how to react to incoming data by themselves.  He does not want them to react to how they think the Fed will view the data.  The risk is that the markets' tendency to overreact to information will be even greater, although he didn't say this.  This week, key data are mostly expected to be on the stronger side.  They would indicate solid economic growth (stock market positive) but possibly lift longer-term Treasury yields (stock market negative).  Iran war developments may have turned positive, at least for the moment.  Dollar-Yen intervention in the FX market could have mixed implications for stocks

Fed Chair Warsh gave the impression the Fed is not ready yet to take a leadership role in steering the economy toward the 2% inflation goal at last week's post-FOMC news conference.  He said Committee members focused at the Meeting on analyzing issues -- separating the effects of price shocks (stemming from the Iran war, tariffs and AI) from underlying inflation and how monetary policy tools could work to bring inflation down.  He said there was broad consensus on the Fed's commitment to hitting its inflation target and that it has the tools to do so.  Warsh did not say members focused on how or when the Fed would use them.  And, the whole discussion, as described, seems to have been academic and an avoidance of debating the timing of a rate hike.

Warsh seems to want to wait to hear from his Task Forces before making a decision.  And, he said he will be hearing from them within the next several weeks.  He suggested he might discuss the Task Forces' missions at the Jackson Hole Conference (August 27-29).  Meanwhile, he is counting on the markets to take the lead and react to incoming data.  However, he said the Fed will not be constrained by market views on monetary policy.  So, a market's expectation for a September rate hike is not a guarantee the Fed will move then.

Indeed, Warsh conceivably may view a reliance on markets to tighten as a way to avoid a politically sensitive hike in the Fed funds rate.  By insisting the Fed wants to lower inflation, he signals the Fed's goal to the markets, expecting them to move in ways that will achieve that goal.  If this interpretation is right, the funds rate will stay where it is in coming months and Warsh will continue to assert the Fed's desire for lower inflation while the markets react to incoming data.  The question will be whether Warsh loses credibility by not following his words with action. 

Alternatively, it is conceivable that last week's decision to keep rates unchanged reflected a desire by a majority of FOMC members to maintain former Fed Chair Powell's "wait and see" policy approach.  If that's the case, Warsh may not control the FOMC, unlike prior Chairs.  His talk of the Fed having a "laser focus" on fighting inflation may have to be discounted.  Also, upcoming July and August inflation data could be critical to the Fed's decision whether to hike rates at the September 15-16 FOMC Meeting.  Benign data could keep rates steady.  The July CPI will be released August 12 and the August CPI September 11.  

This week could test Warsh's reliance on markets to respond appropriately to US economic data.  Key data are expected to improve m/m, pointing to a speedup in economic growth in Q326.  The strength would be consistent with the Atlanta Fed model's preliminary estimate of 5.0% (q/q, saar) for Q326 Real GDP Growth, after Real GDP rose 1.5% in Q226.  

The July Employment Report is expected to show a speedup in job growth.  Consensus looks for Nonfarm Payrolls to climb 91k m/m, versus +57k in June.   The Unemployment Claims data support the idea of a speedup.  Although consensus expects a rebound in the Unemployment Rate to 4.3% from 4.2%, both the dip in June and uptick in July could be chalked up to noise.  The Bureau of Labor Statistics says such small moves are not statistically significant.  Moreover,  the risk is that the Unemployment Rate prints below consensus, based on the Claims data.  Rounding analysis also suggests the risk is for a below-consensus print.  The un-rounded Unemployment Rate was 4.19% in June.

The wage data can be important, as well.   Consensus sees a trend-like 0.3% m/m increase in Average Hourly Earnings,(AHE) matching June's increase.  This pace would be consistent with 2% price inflation if Productivity Growth is trending in the 1.5-2.0% (annualized) range.  A problem, however, is that Productivity has been weak so far this year, up only 0.7% (q/q, saar) in Q126 and expected at 0.3% in Q226 (released on Thursday).  Productivity will most likely jump in Q326 if the Atlanta Fed model's GDP estimate is right, which could bring this year's trend back in the desired range.  So, a 0.3% m/m print for AHE would probably be taken in stride by the market.  A higher print should be a negative and vice versa.

Most other data this week are expected to improve.  In particular, the Mfg ISM is expected to rise to 54.0 in July from 53.3 in June, bringing it back to the March level.   Construction Spending also is expected to speed up, to +0.2% m/m in June from +0.1% in May.  However,  the JOLTS Data' Job Openings are seen pulling back to 7.25 Mn in June from 7.59 in May, suggesting a dip in the demand for workers (belied by a stronger Payroll print in July).