When You Come to the Fork in the Road, Take It

As expected, the Federal Open Market Committee left short-term interest rates unchanged and indicated that it “will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion, with a strong labor market and inflation near its symmetric 2% objective.” Senior Fed officials were divided on whether it will be appropriate to lower short-term interest rates by the end of the year, although even those expecting no change felt that the case for easier policy had strengthened. The Fed “will look at everything” in deciding its next move, according to Chair Powell, but the key issue is whether cross- currents, including trade developments and concerns about global growth, will “continue to weigh on the outlook and thus call for additional monetary policy accommodation.” While Powell signaled that the Fed’s July 31 rate decision will be conditional on the information received between now and then, financial market participants heard a different message and are fully factoring in a rate cut.

At every other FOMC meeting, senior Fed officials revise their projections of growth, unemployment, and inflation. The median forecast for GDP growth in 2019 remained at 2.1% (4Q19/4Q18), boosted by “a surprisingly strong” 1Q19. However, Powell noted that “the unexpected strength was largely in net exports and inventories – components that are not generally reliable indicators of ongoing momentum.” Consumer spending and business investment are “the more reliable drivers of growth.” Consumption was weak in 1Q19, but appears to have bounced back. However, the available data suggests that “growth in business investment has slowed in 2Q19,” while “manufacturing production has posted declines this year.” While the baseline outlook remains favorable, according to Powell, “many FOMC members cited the investment picture, weaker business sentiment, and cross currents as supporting their judgement that the risk of less favorable outcomes has risen.”

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Inflation, as measured by the PCE Price Index, had been close to the Fed’s 2% objective last year, but has decreased this year. Wages are rising, “but not at a pace that would provide much upward impetus to inflation,” according to Powell. Moreover, “weaker global growth may continue to hold down inflation around the world.” The Fed remains firmly committed to its symmetric 2% inflation objective, and officials “are well aware that inflation weakness that persists even in a healthy economy could precipitate a difficult-to-arrest downward drift in longer-run inflation expectations.” Combined with concerns about the downside risks to growth, FOMC meeting participants “expressed concerns about a more sustained shortfall in inflation.”