Federal Reserve Beige Book: A rate cut is not about the US economy

The basic notes of the US economy, success on the consumer and labor sides coupled to an apprehensive business sector remained the status quo in the latest Federal Reserve report issued on Wednesday.

“Economic activity continued to expand at a modest pace overall from mid-May through early July, with little change from the prior reporting period,” noted the anecdotal ‘beige book’ survey of the economic conditions in the 12 Federal Reserve districts.  

“The outlook generally was positive for the coming months, with expectations of continued modest growth, despite widespread concerns about the possible negative impact of trade-related uncertainty,” said the book.

The report is prepared for each FOMC meeting, in this case on July 30-31^st when the central bank is widely expected to reduce the fed funds rate for the first time since September 2008.  Even though US growth appears to have ebbed in the second quarter from its 3.1% annual pace in the first three months of the year, the report should allay any fears that the economy is sliding towards recession.

Federal Reserve officials have strongly hinted that concerns about the slowing global economy, the trade dispute with China and the disruptive potential of the British exit from the EU are inclining the governors to cut the base rate. 

Market expectations based on the fed funds futures place the odds of at least a 25 basis point cut at the end of the month at a certainty with a substantial chance for a 50 point decrease from the current 2.5%.  For the September 19^th FOMC the futures rate the odds of a second rate cut at 78.4%

Despite the pending rate cut the dollar has improved from its lows of two weeks ago as the sterling and the euro have been dragged down by Brexit fears and the united currency by the ECB assertion that rate action is possible should it become warranted.

In the US businesses saw consumer spending as helpful. Retails sales rose 0.4% in June, much better than the 0.1% forecast, and have now increased for four straight months and five out of the last six.  Sales in the control group category that the government uses to calculate the consumption component of GDP climbed 0.7% more than double the 0.3% prediction.  They have also been positive for four months in a row and five of the last six.  

Good wage growth, job creation and low unemployment are underpinning consumer optimism.  Wages expanded at 3.1% annual rate in June and business hired 224,000 new employees producing a 3.7% jobless rate, the lowest in five decades. Consumer confidence is healthy though lower than its very high levels of last year.

Reuters

Inflation remains muted with the core PCE index at 1.6% in May and the overall rate at 1.5%.

Manufacturing executives voiced concerns about the trade argument with China, as they have for over a year and many said that new workers were difficult to find.

In his testimony before Congress last week, Fed Chairman Jerome Powell signaled that the bank is ready to cut rates.  Markets have taken this a promise and at this point it might be difficult for the FOMC not to keep its intention.  Whether a reduction would be the beginning of a rate cycle is, with the economy far from needing support, an open question, whatever the futures might say.