HIGHLIGHTS OF THE WEEK

  • Fed hiked rates by 25 bps this week as widely expected. But, the communiqué dropped the reference to policy remaining “accommodative”. Interpretations regarding this change led to volatility in bond yields and equities.
  • The debate on textual changes in the Fed statement detracts from the main point: the Fed remains committed to additional tightening – a message echoed by a broadly-unchanged rising interest rate path in the Fed dot plot.
  • Despite not being all positive, economic data reaffirmed the notion that the U.S. economy remains on solid footing. Of note, real personal spending rose 0.2% in August, keeping our tracking for Q3 consumption above 3% (ann.).

 

 

Don’t Let Textual Changes Get in the Way of Rate Hikes

The September FOMC meeting was the highlight of this week’s economic calendar. The Fed did not disappoint, hiking the Fed Funds rate by 25 bps as widely expected. This lifted the upper bound target to 2¼ % – the highest level since 2008 (Chart 1). The policy path ahead remained broadly unchanged as per the Fed dot plot. What’s more, the funds rate is now projected to remain above the longer-run neutral level through 2021.

Market focus however, gravitated more toward what was not in the Fed statement, rather than what was in it. The communiqué dropped the reference to policy remaining “accommodative”. This received a dovish interpretation initially under the premise that the Fed may be getting close to the end of the hiking cycle, leading to volatility in bond yields and equities.

The debate around textual changes in the Fed communiqué appears to detract from the main point – the Fed remains committed to further gradual tightening given its conviction for well-anchored inflation expectations and a positive view of the economy. Economic data in the week remained broadly in line with this narrative. The Fed’s preferred measure of inflation held right on target for the fourth straight month in August. Meanwhile, real personal spending was up 0.2% in the same month. While this marks a slight moderation in the monthly pace of spending, it’s sufficient to keep our tracking for third quarter consumption growth north of 3% annualized. A solid rise in wholesale and retail inventories added to the positive tally.

Not all of the data was positive though, with soft pockets including trade and housing. The goods trade deficit widened more than expected in August. The first two months of the quarter reaffirm the notion that, unlike the second-quarter experience, net trade will be a drag on growth this time around. Pending home sales, a leading indicator of sales activity, also fell 1.8% in August (Chart 2). This marks the fourth decline in five months, suggesting that sales will continue to languish in the near-term.

Putting all the pieces together, the economy is still on solid footing, with over 3% growth expected in the third quarter. With price pressures holding near target, this should indeed be sufficient for one more hike before the end of the year. Beyond this point, however, there is significantly more uncertainty, as trade disputes pose significant downside risk to the economic outlook.

The U.S.-China trade conflict saga continued to play out in the background, given other more salacious domestic political developments. China scrapped talks with the U.S. as tariffs on $200 bn of Chinese goods came into effect. Meanwhile, President Trump accused China of attempting to interfere in the upcoming midterm elections, given his stance on trade. With the two economic heavy-weights on a hard-to-avoid collision course, we see this dispute as a key risk to growth. Tariffs in effect and those threatened could knock off up to 1 p.p. from U.S. and 0.3 p.p. from global economic growth (see here).

 

Admir Kolaj, Economist | 416-944-6318

 

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