FOMC Rate Decision on Wednesday

• After last week’s slow grind higher in yields, the FOMC will highlight a busy week with a rate decision on Wednesday. While expectations are that the Fed will pause and perhaps tee-up a rate hike for the September meeting, new Fed Chair Warsh has shown a willingness to throw convention to the side, so there is still a possibility he tries to convince the Committee to move now and not later. Aside from the FOMC meeting we will get a solid dose of first-tier data headlined by the June PCE inflation reading along with personal income and spending data. While the upward move in oil and yields may have dulled some of the expectation around the Fed’s preferred inflation gauge, it will still provide a useful guide for investors. Also, while the weekend brought renewed hopes of peace negotiations in the Middle East, and cheaper oil, but there is the likelihood that events shift again and influence trading, as we’ve already seen numerous times since February. Currently, the 10yr is yielding 4.65% down 3bps, while the 2yr is yielding 4.32%, down 1bp on the day.

 

• The Fed begins two days of meetings tomorrow with a rate decision on Wednesday at 2pm ET. Odds currently sit at 36% for a rate hike, so it would be something of a surprise to see a hike at this meeting, but Fed Chair Warsh has certainly wanted to not just pick up the baton from former chair Powell but operate in a different fashion. We do think this will be a hawkish hold, with the Fed setting the stage for a hike in September when they have more information on inflation and of course, more time to ponder the developments in the Middle East.

 

• Arguing against a rate hike would be the June inflation numbers which were decidedly cooler than expected and a welcome relief to all. However, Fed members, including Fed Chair Warsh, were quick to point out not to read too much into a single month’s report. And with oil prices moving higher this month it has the potential to turn the June numbers into a one-and-done scenario. Still, one can argue that a rate hike won’t solve the supply constraints in energy markets, nor is the economy over-heating by any stretch with the Atlanta Fed’s GDPNow model predicting second quarter GDP at just 1.7%.

 

• Still with Warsh limiting any forward guidance, the transparency of the Powell Fed is not present and that creates the potential for more volatility around an outcome that remains somewhat in question. In addition, Warsh seems intent on creating a new Fed model, or at least, one departing from recent history. While he may wish to show that he’s his own man and deliver a rate hike on Wednesday could he muster six more yes votes on the committee? We don’t think so. While there were some recent Fed voices that seemed to be moving from a cut or hold position closer to hiking, the institution has a long history in being deliberative in its actions such that a second meeting for the new Fed Chair seems a bit ambitious for him to wrangle the necessary votes in the current environment. In any event, the vote count will certainly be an interesting bit of information to come from the meeting.

 

• Away from the Fed story, we’ll get plenty of economic reports this week to make up for the data void last week. The reports start with today’s Preliminary Durable Goods Orders for July. Orders increased 0.3% vs. 1.8% expected and -4.0% the prior month. Orders ex-transportation increased 0.6% vs. 0.8% expected and 1.8% in May. Order ex-transportation and defense rose 0.9% vs. 0.7% expected and 1.9% in June.

 

• The other big report will arrive on Thursday, just after the FOMC meeting, and that will have the Fed’s preferred inflation measure, PCE, for June. It’s the last of the June inflation reports and coming after the Fed meeting dulls some of its importance, not to mention the upward move in oil in July. Be that as it may, expectations are for overall PCE inflation to decrease -0.1% MoM and 3.7% YoY vs. 4.1% YoY in May. Core PCE is expected to have increased 0.2% MoM and 3.3% YoY vs. 3.4%n YoY in May. Despite the expected cooler inflation numbers for June, the upward move in oil and gas prices in July certainly casts the June low inflation prints as a one-and-done event.

 

• The same report carries with it the personal income and spending numbers for June. Incomes are expected to increase 0.3% vs. 0.7% in May and spending is expected to have increased 0.4% vs. 0.7% the prior month. Spending adjusted for inflation is expected to have also risen 0.4% vs. May’s 0.3% real gain. Annualized, that’s above 4.5% and certainly indicative of the resilience we’ve seen from the consumer in this economic cycle. While those figures, if realized, point to another solid month of income and consumption it would not indicate an overheating economy which is again one big reason we think the Fed refrains from hiking this week, but rather begins to lay the groundwork for a hike in September where the odds are currently at 80% for such a move.

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Odds for Hike this Week at 36%Source: CME Group

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Odds for September Hike at 80%Source: CME Group

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Atlanta Fed’s GDPNow Model Estimates Second Quarter GDP at 1.7%Source: Atlanta Federal Reserve Bank