Markets Are Hopeful For Fed Clues

While the markets wait for no man, the FOMC is a different story. Janet Yellen is expected to lead the Federal Reserve into taking the first step toward normalizing monetary policy in the coming months. Although the statement she crafts is unlikely to contain an overt signal of a hike at the next FOMC meeting in September, it is expected to acknowledge that the economy is moving toward the central bank’s goals. 

Indeed, last week, initial jobless claims fell to new cyclical lows. There were the fewest filing for unemployment benefits since 1973, despite a significantly larger work force and population. Tomorrow the government provides its first estimate of Q2 GDP, and a rebound is widely anticipated after the near-stagnation in Q1. 

The FOMC statement today will not be followed by a press conference or new forecasts. We regard the statement as the clearest signal from the Fed’s leadership. The minutes and forecasts have more noise as the underlying signal is obscured by the cacophony of views and interpretations. Yellen has ushered the Fed from its date dependent guidance to a data focus. There is no reason to abandon this and tip its hand. There are still two employment reports to be seen before the September meeting. By our calculations, the September Fed funds futures contract is pricing in roughly a 50% chance of a September. We would attribute somewhat higher odds. 

Yellen seemed clear in her recent Congressional testimony. While the Fed is monitoring international developments, the knock-on effect from the Greek drama and the fall in Chinese shares is manageable. The US economy has proven fairly resilient. She also responded to the call in some quarters, including from the IMF, that lift-off should wait until next year. Yellen argued that an earlier move may allow for a more gradual pace of normalization while waiting longer could force more dramatic action.   

It is true that commodity prices, including energy prices, have weakened. Unlike most central banks, the Fed looks through such weakness, arguing that its impact on inflation in transitory, and focuses on a core rate to set policy that excludes food and energy. Of course, some weakness in commodity prices does bleed into the core measure, and the Fed takes this into account as well. Ultimately, the Fed officials, like many economists, see labor costs as the key to core inflation, and that over time headline inflation converges to core inflation.