United States: Some Tweaks, But No New Signals From the FOMC
David Greenlaw (New York)
The outcome of the FOMC meeting was as expected — a unanimous vote for a 25 bp rate hike and no change in the formal risk assessment. However, the official statement accompanying the action contained more changes than we had thought likely. Most importantly, the adjustments sent a mixed signal and do not appear aimed at altering expectations for further rate hikes. Indeed, we certainly believe that the FOMC remains on track to tighten again at the November 10 meeting.
Here is a comparison of the wording changes in the statement:
August 10
In recent months, output growth has moderated and the pace of improvement in labor market conditions has slowed. This softness likely owes importantly to the substantial rise in energy prices. The economy nevertheless appears poised to resume a stronger pace of expansion going forward. Inflation has been somewhat elevated this year, though a portion of the rise in prices seems to reflect transitory factors.
September 21
After moderating earlier this year partly in response to the substantial rise in energy prices, output growth appears to have regained some traction, and labor market conditions have improved modestly. Despite the rise in energy prices, inflation and inflation expectations have eased in recent months.
So, the message was more upbeat on the current state of the economy but referenced an easing of inflation and inflation expectations. Admittedly, we were a bit surprised that the FOMC dropped the optimistic forward-looking assessment that had appeared in the August statement ("... poised to resume a stronger pace of expansion going forward"). However, the omission is understandable when viewed in conjunction with the reference to the economy regaining "some traction" in the latest statement. Assuming the Fed now sees Q3 GDP running in the neighborhood of +4%, then a reference to resuming a "stronger pace of expansion going forward" may no longer be valid. In other words, at this point, there is no reason to believe that Q4 growth will be significantly better than +4%. Still, a 4% growth trajectory is strong enough to keep the Fed in tightening mode. Thus, we are not inclined to read too much into this modification in the statement.
Finally, the reference to moderating inflation can be interpreted as an "I told you so" from the Fed. The core CPI has dipped from a year/year pace of +1.9% in June to +1.7% in August. Moreover, the median expected inflation component of the University of Michigan survey has slipped from a peak of +3.3% in the spring to +2.9% in early-September. The Fed has been quite vocal in expressing a view that the run-up in core inflation seen earlier this year would not continue. However, expected inflation is still a bit above the +2.6% average that has prevailed over the prior six years. And, with monthly average core CPI running below 0.1% in the final four months of 2003, the year/year pace should tick up a bit over the balance of this year. From our standpoint, inflation is not going to be a trigger for more Fed tightening anytime soon but, at the same time, the inflation data are unlikely to be a catalyst for a pause in the tightening campaign.
We subscribe to the two-stage tightening theory. In the near term, the bar for further rate hikes is still quite low — the Fed doesn't need strong incoming data to move again in November, just data that is not terribly weak. Further down the road, the bar is likely to be raised and it will take an indication that the economy is expanding faster than the perceived potential growth pace of +3.5% to +3.75% to keep them on a gradual tightening path.
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