Markets and pundits were hyperventilating this past week over the prospect that the FOMC might cut the fed funds rate at its June or perhaps at its July meeting, driven by concerns that the economy might be slowing, as reflected in the disappointing employment report and the prospects for the imposition of import tariffs on Mexican goods. This view was fueled by statements by Chairman Powell and other FOMC participants that they stood ready to respond should there be negative fallout from the trade disputes.
The positive stock market reaction reflects a fundamental misunderstanding of what the FOMC’s policy approach is, what message the Fed officials were sending, and the circumstances the FOMC is facing.
One way to look at the issue is that the Fed has consistently indicated for more than a year that its rate decisions will be “data-dependent”. At the Chicago Fed’s recent conference on reassessment of the Committee’s policy framework, all that Chairman Powell and others who commented did was to spell out what kind of data might trigger a cut in rates, given the current economic and political environment. Specifically, with all the uncertainty about the tariff situation, the Fed would have to be blind, deaf, and dumb not to see and acknowledge the threat to the real economy that imposition of tariffs on Mexico would have on key industrial sectors, like autos. Such punitive tariffs might even trigger a recession. Of course, it should also be obvious that a 25-basis-point cut in rates would not offset the costs or impacts of the imposition of tariffs on Mexican imports, nor would it replace the falloff in Chinese soybean demand.
Fortunately, based on the President’s announcement Friday evening, the immediate Mexican tariff threat now seems to be off the table. So what now are the key data elements that the Fed will be looking at for its upcoming meeting, and what might available data say about the need for a rate cut, keeping in mind that the FOMC staff had already included a near-term slowdown in the forecasts that were the basis of the “patience” policy stance coming out of the April-May meeting? Clearly, there are some plusses and minuses in the available data.
On the plus side, first-quarter real GDP growth was 3.1%, which is arguably above-trend growth. The unemployment rate is at a 50-year low at 3.6%, and labor markets are strong. New claims for unemployment insurance are running about 225K per week and are not only low by historical standards but also at all-time lows as a percentage of the labor force. Additionally, we continue to have more job vacancies than we have job seekers who are unemployed. Despite the tight labor market the recently released Manpower survey showed that 27% of the survey respondent planned to add workers in the third quarter, a 13 year high. The most recent data on productivity, which has been mired in the doldrums for most of the recovery, may finally be showing signs of a rebound, increasing 3.4% in the first quarter of 2019 (compared with a year-over-year increase of 2.4%). Similarly, unit labor costs also decreased, reflecting the increase in productivity without labor cost pressures. Consumer debt increased in the latest report and signals increased spending on the part of consumers. At the same time, small-business optimism is actually up, according to the most recent NFIB survey.
On the negative side, the housing market has softened; manufacturing output has weakened; and durable goods orders are off as well. But the number that has caught everyone’s attention is the weak CES jobs number, which came in at 75K. Not only was the number about 100K below expectations, but the previous two months data were revised down – for March from 189K to 153K, and for April from 263K to 224K, making the totals about 75K less than previously reported. Job gains for 2019 have averaged 164K per month, compared with 223K per month for 2018. But one month’s data doesn’t necessarily signal a trend, and it is risky to focus on a given month’s data. In February only 56K jobs were created, but this low was followed by 153K and 224K the next two months. Similarly, in September 2017 the economy created only 18K jobs, but then it generated 260K jobs in October of that year, 220K in November, and 170–171K the next two months.
What more data will the FOMC have as it contemplates policy for June? We know there will be a new set of SEP forecasts, so those should provide additional insights into how the Committee views the rest of 2019 and whether it thinks near-trend growth is possible. We also know that there is a new Beige Book, and it is useful to see how the information from the districts has or has not played into how the FOMC has characterized the economy recently.
The following table shows that in December 2018, when GDP growth was 2.2% on a year-over-year basis, half the districts reported moderate growth, which typically means about 2.2–2.4%, while all but two of the rest reported modest growth (something less than 2% – slightly less than moderate). The FOMC, however, characterized growth as rising at a solid rate. District estimates for the three meetings in the first quarter of 2019 suggested that economic activity was not as robust, and the FOMC stated that economic activity had slowed somewhat in the first quarter of 2019 as compared with 2.2% growth in Q4 2018. We know, however, that real GDP growth in the first quarter turned out to be a full percentage point stronger, at 3.2%, than it was in Q4 2018. Looking forward to the June meeting, the districts are suggesting that activity was not even as strong as what they saw for Q4 2018. It appears that there may be a disconnect between what the districts are reporting and how the FOMC distills the information at the meeting, even when compared with the actual outcomes.
So, is there any other information in the form of incoming data, beyond what we presently have, that may serve to further inform policy makers at the upcoming meeting? In addition to the SEP forecasts and FOMC staff forecast, some relevant but probably not decisive data will be coming out between now and the meeting. These include data on PCE and CPI inflation; the weekly jobless numbers and job openings and turnover information (JOLTS); retail sales; and manufacturing information for May, including capacity utilization, industrial production, inventories, and housing data. Interestingly, the available data on trade showed that in April the overall deficit decreased slightly to $50.8 billion as both exports and imports contracted; but interestingly, the trade deficit with China, which has been the focus of so much attention from the administration, actually increased 29.7% to $26.9 billion, more than half the country’s overall trade deficit for the month.
All this suggests that the FOMC will face a somewhat easier time at its June meeting than it would have faced had the trade issues with Mexico not been averted. What is left is a picture of an economy that is growing at trend and one that was already expected by the FOMC to slow somewhat from the 3.2% GDP number for the first quarter. This picture is in line with the forecast discussed in the last meeting minutes. With the labor market still exceedingly tight and financial conditions extremely accommodative, at least as suggested the Chicago Fed’s broad-based National Financial Conditions Index, it seems there is no pressing need for the FOMC to deviate at this time from the policy path the Committee laid out the last time its SEP forecasts were revealed. To move to cut rates now, given the present rather benign economic situation, risks sending an inadvertent message to markets that the Fed sees serious enough concerns ahead that it needs to act pre-emptively, when that may not be the case.