Meeting Minutes, Higher Rates

Yesterday afternoon the latest July 27 FOMC meeting minutes were released, suggesting at least some growing fears of downside risks to the economy. During the July press conference, following the Fed’s decision to raise rates a second-round 75bps to 2.25-2.50%, Fed Chairman Jerome Powell made a material deviation from an earlier characterization of strength regarding the U.S. economy, instead highlighting the domestic economy’s loss of momentum, noting spending and production specifically have?"softened.”?This more sour sentiment buoyed expectations for a more benign policy pathway going forward.

According to the July 27 meeting minutes, released yesterday, other Fed officials equally voiced concerns about mounting weakness in domestic activity and the potential need for a slower pace of rate hikes, allowing the Committee time to better assess conditions and the impact of earlier rate increases. In fact, some noted the risk of tightening too much, or moving rates higher than necessary to rein in inflation given the sizable lag in policy effects.?

“As the stance of monetary policy tightened further, it likely would become appropriate at some point to slow the pace of policy rate increases while assessing the effects of cumulative policy adjustments on economic activity and inflation.”

“Many participants remarked that, in view of the constantly changing nature of the economic environment and the existence of long and variable lags in monetary policy’s effect on the economy, there was also a risk that the committee could tighten the stance of policy by more than necessary to restore price stability.”

-July 27 FOMC Meeting Minutes

At the same time, while officials appear in agreement that it will?eventually?be appropriate to lessen the size and slow the pace of rate hikes, the Committee also remains focused on reinstating price stability and committed to raising rates until inflation is on a sustainable downward path. In fact, even as Powell and company appear to be increasingly aware of the emerging weakness, the Chairman himself left the door open to another?“unusually large”?increase next month as decisions are being made meeting to meeting and based on the latest, incoming data.

“With inflation remaining well above the Committee’s objective, participants judged that moving to a restrictive stance of policy was required to meet the Committee’s legislative mandate to promote maximum employment and price stability,”?the minutes stated.

“Participants judged that a significant risk facing the Committee was that elevated inflation could become entrenched if the public began to question the Committee’s resolve to adjust the stance of policy sufficiently,”?the minutes said.?“If this risk materialized, it would complicate the task of returning inflation to 2 percent and could raise substantially the economic costs of doing so.”

Bottom Line:?The Fed has acknowledged the need to slow the pace of rate hikes in order to evaluate the impact of already 225bps in tightening. That being said, while the Fed may be willing to reduce the size of rate hikes going forward, the Committee is not willing to cease further increases altogether without first establishing a meaningful reduction in price pressures. In other words, while the Committee remains optimistic price stability will eventually return, the Committee is not willing to hang the?“mission accomplished”?banner until a clear downward trend has been realized with several months of improving data.

So what does this mean for September? As long as the market maintains expectations for a 50bp hike, currently at 64% probability, the Fed is likely to capitulate to a reduced increase while still emphasizing its commitment to controlling inflation. If, however, the August inflation report comes in hotter than expected, redirecting market expectations to a larger hike, the result will expectedly be a third-round 75bp increase.

Equities are trading higher with the Dow up 0.07% at 33,988 as of 8:46 a.m. ET.

Yields, however, are moving lower with the 10-year down 2bps at 2.88% as of 8:47 a.m. ET.

Also yesterday, retail sales were flat (0.0%) in July, falling short of the 0.1% gain expected and the weakest monthly pace since December of last year. June sales, meanwhile, were revised down from a 1.0% gain to a 0.8% increase. Year-over-year, however, retail sales jumped 10.3% in July, the largest gain in five months.

Car sales fell 1.6% in July following a 0.5% increase the month prior, while gasoline stations sales dropped 1.8% following a 2.5% gain the month prior. Excluding autos, retail sales rose 0.4% in July and climbed 12.3% over the past 12 months. Excluding autos?and?gasoline, retail sales gained 0.7% and increased 9.3% year-over-year.

In the details, non-store retailer sales jumped 2.7%, miscellaneous sales rose 1.5%, and eating and drinking sales climbed 0.1% in July, following a 0.8% increase in June. Also, sporting goods sales rose 0.1%, food and beverage sales gained 0.2%, and furniture sales also increased 0.2% in July. Additionally, health and personal care sales increased 0.4%, and building materials sales rose 1.5% in July, following 0.5% decline in June. On the weaker side, clothing sales fell 0.6%, and general merchandise sales dropped 0.7%, due to a 0.5% decline in department store sales.

Bottom Line:?Lower gas prices in July meant fewer dollars spent to fill up the family car, but it also meant additional cash to spend on other areas. The former is evident in yesterday’s report, the latter, less so. Excluding gasoline, retail sales remain lackluster and outright negative after accounting for inflation. While any reprieve is welcome, lower prices at the pump are not enough to offset rising costs in other key categories of expenditures, leaving consumers under pressure as their purchasing power continues to be eroded by elevated inflation. While a weak consumer is further evidence economic momentum is waning, it also compounds the need for the Fed to rein in cost pressures.

This morning, initial jobless claims unexpectedly declined 2k from 252k, revised down from 262k, to 250k in the week ending August 13, the first decline in three weeks. According to?Bloomberg, jobless claims were expected to rise to 264k. Continuing claims, however, or the total number of Americans claiming ongoing unemployment benefits, rose from 1.43M to 1.44M in the week ending August 6.

Also this morning, the Philly Fed Index jumped from -12.3 to +6.2 in August, a four-month high. According to?Bloomberg, the index was expected to rise to -5.0. In the details of the report, shipments rose ten points to 24.8, new orders increased from -24.8 to -5.1, and the number of employees ticked up from 19.4 to 24.1, a two-month high. On the other hand, prices paid declined from 52.2 to 43.6 and prices received fell from 30.3 to 23.3 in August.

Additionally this morning, the Leading Index fell 0.4% in July, less than the 0.5% drop expected and the fifth consecutive month of decline.

Finally this morning, existing home sales dropped 5.9% from 5.11m to 4.81m in July, a more than two-year low, and the sixth consecutive month of decline. Existing home sales were expected to decline 5.1% at the start of Q3, according to?Bloomberg. In the details, single family sales fell 5.5% and multi-family sales decreased 9.1%. Year-over-year, existing home sales plunged 20.2% in July, the twelfth consecutive month of decline. As a result of a decline in sales, the months’ supply of existing homes rose from 2.9 months to 3.3 months, averaging 2.9 months over the past three months. From a price standpoint, the median cost of a previously owned home rose 10.8% in July from a year earlier to $404k, a three-month low.

In international news, as the Fed debates its next policy move five weeks from now, other central banks around the world are continuing their march higher. Norway’s central bank, the Norges Bank, for example, hiked its key lending rate from 1.25% to 1.75%, while suggesting a second-round 50bp hike may be on the table next month. The Philippines central bank increased rates by 50bps to 3.75%, the fourth rate hike this year.

Earlier, the European Central Bank opted to raise rates 50bps, taking the key deposit rate from -0.50% to 0.00%, the main refinancing operations rate from 0.00% to 0.50% and the marginal lending facility rate from 0.25% to 0.75%. The move marked the region’s first hike in 11 years, effectively ending the Eurozone’s period of negative rates which began in 2014. The Bank of England, meanwhile, pushed borrowing costs up 50bps to 1.75% earlier this month, double the previous rounds of 25bp hikes, marking the sixth increase since December and the largest increase in nearly 30 years.

Turkey, on the other hand, unexpectedly cut rates by 100bps from 14% to 13%, despite inflation reaching a 24-year high. And the People's Bank of China recently cut its one-year lending facility rate from 2.85% to 2.75% and cut the seven-day lending rate from 2.1% to 2%. Additionally, in an effort to further stimulate growth, the People’s Bank of China injected more cash – 2 billion yuan – into its economy.

This afternoon, at 1:20 p.m. ET Kansas City Fed President Esther George is scheduled to speak on the economic outlook at an event hosted by the Fairfax Industrial Association in Independence, Missouri. Also, at 1:45 p.m. ET, Minneapolis Fed President Neel Kashkari is expected to speak in a Q&A session at the monthly gathering of the Young Presidents Organization Gold Twin Cities Chapter.

Tomorrow, the economic calendar is empty.

-Lindsey Piegza, Ph.D., Chief Economist