Fed Pleased With ‘Strong’ U.S. Economy, Repeats Call For ‘Gradual Rate Increases’

On July 19, Donald Trump threw a monkey wrench into the Fed’s decision calculus when, in an interview with CNBC’s Joe Kernen, the President articulated his displeasure with the current path of U.S. monetary policy.

The next day, Trump took things up another notch, explicitly blaming the Fed for undermining his efforts to engineer an economic miracle on the way to questioning the relative wisdom of Fed hikes amid the trade war.

“Tightening now hurts all that we have done”, Trump tweeted, before claiming that America is entitled to “recapture what was lost due to illegal currency manipulation and BAD Trade Deals.”

“Debt coming due & we are raising rates – Really?,” Trump went on to shout ask.

Yes, Mr. President, “really.” And in an irony of ironies, the reason that’s necessary is because when you pile fiscal stimulus atop an economy operating at full employment, you risk overheating that economy and driving up inflation. On top of that, the tariffs also risk pushing up domestic prices. Indeed, there’s evidence to support the contention that protectionism exerts steepening pressure on a Phillips curve that would already be inclined (get it? “inclined”) to reassert itself in a late-stage expansion.

As far as the debt is concerned, if Trump is worried about that, he might consider whether it was a good idea to pass deficit-funded tax cuts and then, just months later, throw caution further to the wind by backing more spending.

Now, any dovish lean by Jerome Powell could be criticized as a concession to Trump and a sign that the White House is encroaching on Fed independence. In other words, verbal interventions from the President actually do the opposite of what Trump intends – they seemingly constrain Powell’s ability to take a pause should the committee believe such a pause is necessary in light of, for instance, emerging market turmoil.

“We previously argued that the new Fed will likely be in sync with the Trump administration, which likes low rates, a weaker USD, and higher debt [but] regardless of whether this materializes, our view is that a slower pace of hiking is the right thing to do given the divergence of US and international rates, as well as the enormous left tail risk of a potential late-cycle policy error”, JPMorgan’s Marko Kolanovic wrote, in a note dated Monday, adding that “should the Fed skip one hike, it would be a risk-on catalyst, lifting EM assets in particular.”

Whatever the case, the Fed is generally seen as laying the groundwork for a September hike and Wednesday’s statement will be parsed for signs that the committee continues to have faith in the durability of recently robust U.S. economic data (“amazing” data, if you ask Trump).

“On the policy statement, we only look for modest changes marking the language to the latest data such as the rise in the unemployment rate, though we expect the Committee will note that it remains at low levels”, BofAML writes, in their preview. Goldman largely echoes that assessment:

Reflecting the upbeat growth picture, we expect the post-meeting statement to retain most of the positive characterizations from the June meeting, referring to growth as “solid,” job gains and business investment as “strong,” and consumer spending growth as having “picked up.” While we expect a nod to the higher June unemployment rate, the tweaks are likely to be relatively minor (to “has stayed low” from “has declined”), particularly because wage growth measures have been stable-to-higher in recent months.

“The Fed needs to tweak the statement when it feels the market expectations are out of step with them”, Bloomberg’s Ye Xie wrote on Wednesday afternoon, before noting that “given 2018 rate expectations are right at where the Fed‘s Dot Plot is, the Fed can perhaps push the snooze button this afternoon.”

As alluded to above, this is all playing out against the trade war drama, which is why Trump is so concerned about dollar strength and policy divergence. Here’s a review of what Fed officials have said recently about the trade war:

(Goldman)

For his part, Powell has generally attempted to avoid getting drawn into the trade discussion although when pressed, he’s admitted that trade openness is on balance a good thing for the world.

Despite Trump’s weak dollar rhetoric, USD net long positions jumped for a sixth week in a row to nearly $22 billion overall through last Tuesday. That’s the highest level since January.

(Goldman)

With that, the Fed has of course kept rates unchanged and the assessment of the economy remains upbeat.

What you need to know about today's rate decision in 90 seconds ??https://t.co/Y5Zlkqy2nU pic.twitter.com/Kelh7SLawG

— Bloomberg (@business) August 1, 2018

The committee seems consistent in its messaging on gradual hikes, which makes one wonder how long it will be before someone nips this hiking cycle in the bud…

Full Statement

Information received since the Federal Open Market Committee met in June indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate. Job gains have been strong, on average, in recent months, and the unemployment rate has stayed low. Household spending and business fixed investment have grown strongly. On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1-3/4 to 2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.