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🏦🇺🇸Desk Commentary: FOMC July Monetary Policy Decision

TD Securities:

  • Although the Fed gave itself extra time to assess whether the economy would turn under the weight of 500 basis points in rate hikes over the last 16 months, the economy has continued to exude surprising resilience.

  • The Fed has not seen enough evidence from the economy that it can declare an end to the hiking cycle. The Fed's own forecast shows that members think another hike is likely needed before year-end. Given the new slower pace of rate hikes, the Fed will likely hold rates steady at its next meeting in September. This will give the Fed a three-month window to monitor the economy before it decides whether it should hike again. If the labor market fails to weaken and/or core inflation fails to make the progress they expect, another 25 basis point hike would likely be on offer. As it stands, markets are giving this a 50/50 chance.


  • A bit more hinting from Powell's comments that a lot of ground has been covered and things are getting more into a period where the Fed needs to observe the effects of cumulative tightening filter through.

  • The whole picture and the data that comes is really what's going to be paramount for the Fed going forward. Two more job and CPI reports which are going to inform decisions. These data prints should be well watched and I'm sure the event weights might be adjusted upward for them.

  • This will very much be a wait-and-see approach for how the data goes. The bar is now known - prints similar to the last CPI/nonfarm payrolls reports - but they need more consecutive prints like that. But the September meeting is live and they're going to read the narrative the data spins.


  • There is only one more rate hike left in the dot plot and if the FOMC does not expect a recession, they might as well hike in November. If they wait until November, we expect a recession or at least a significant deterioration in the economy, to prevent them from hiking. This is still our baseline

  • However, with Powell no longer standing in the way of a September hike, the upside risk has increased. Disappointing data on core inflation -the FOMC can be expected to look through a rebound in headline inflation caused by base effects- could still convince the Fed to go ahead in September. Obviously, our baseline forecast for the Fed is also data-dependent. In fact, because in real terms monetary policy has only recently become restrictive, we are sympathetic to more rate hikes. However, because of the “more moderate pace” we doubt whether they will materialize.

  • The minutes of this FOMC meeting will be published on August 16. Before the next FOMC meeting on September 19-20, we get two Employment Reports (August 4 and September 1), two CPI reports (August 10 and September 13), and two PCE reports (July 28 and August 31). The Jackson Hole Symposium on August 24-26 could give Powell a podium to reflect on the first round of data and signal any intention for the September meeting. With two rounds of data before the September meeting, and the FOMC in a data-dependent mode, a lot can still happen between now and then


  • With two months until the next meeting there was no need for the Fed to change its position. A dovish tilt would have led the market to latch onto the possibility of the Fed not hiking further. Treasury yields and the dollar would have fallen significantly, which would loosen financial conditions in the economy. Given low unemployment, robust wage growth and the fact that core inflation is still running at more than double the 2% target, such a market reaction would run counter to the Fed’s aims.

  • Instead the Fed stuck with its hawkish bias with the press conference suggesting that the Fed’s mindset remains focused on ensuring that inflation returns to target sustainability even if that runs the risk of a recession. Chair Powell again referred to the extra rate they included in their June forecast update, which would take the policy rate range to 5.5-5.75% and stated that intermeeting data was broadly consistent with their expectations. Markets though have their doubts with just five basis points of tightening priced for that September FOMC meeting with it being a 50-50 call whether there will be a 25bp hike by the November FOMC meeting.


  • It’s a long eight weeks between now and then, an interval that includes two rounds of employment and inflation readings along with other key monthly indicators. This will be a significant amount of data that the Fed will likely draw some conclusions from. The worry would be that the theme of growth and inflation ebbing, but not fast enough to instill confidence in the restoration of price stability, was still being played at current volumes in two months time. In such a scenario, the Fed would likely raise rates again in September. But, if it’s perceptibly quieter, September would probably be skipped (like June) with the focus shifting to November 1st.

  • Although Powell said that economic resilency was a "good thing" in the context of current disinfation, too much of it "would require an appropriate response" from monetary policy.

  • It’s our forecast that the tug-of-war between the economic headwinds and tailwinds during the coming months will tilt to the former, causing enough growth deceleration and disinflation to turn a September skip into a more prolonged pause. In other words, welcome to terminal territory (but we still have net upside risks surrounding our Fed call).


  • The Fed continues to expect the lagged impact of interest rate increases to-date will slow economic growth and cool overheating labour markets. Our own near-term economic outlook is more pessimistic than the Fed's and inflation has shown substantial signs of slowing. Our own base case assumes that the interest rate increase today was the last of this hiking cycle. But the Fed is clearly willing to push interest rates higher again if inflation were to show signs of reaccelerating.


  • While the cooling in CPI was viewed as favorable, Powell mentioned the need to see more sustained evidence of a cooling, and policymakers will be looking for the labor market in particular to come into better balance. Although the start of a balancing is in evidence, with participation in the core working-age group increasing, job vacancies declining, and wage growth having slowed, demand for workers still exceeds supply.

  • Powell highlighted that consumer spending is slowing, and that the interest-sensitive areas of housing and investment are showing the impact of past rate hikes, but it will take time for the full effects to be realized on inflation, and his view is still that the economy will avoid a recession, as the economic backdrop heading into this rate hike was healthier than expected months ago.

  • Bond yields rose slightly following the statement, but fell sharply during Powell's press conference as he was decidedly unsure that the economy would require higher interest rates ahead, and markets are priced for only roughly 10bps of hikes from here. We still think that a September hike is probable, with job gains likely to remain above the roughly 100K pace that Powell has cited is consistent with a labor market that isn't tightening further. But if, as we expect, job gains and inflation signals continue to cool thereafter, the September hike could prove to be the last for this cycle, with the first easing not likely until Q2 2024, as we’ll also need time for inflation pressures to sufficiently abate.



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