FOMC Minutes July Preview: More new questions than answers

At the July 27-28 Federal Reserve meeting, the policy question seemed straightforward. Was the US economy, particularly the labor market, improving enough to begin the taper discussion?  

The following sentence had been added to the Federal Open Market Committee (FOMC) statement. " Since then, the economy has made progress toward these goals, and the Committee will continue to assess progress in coming meetings.” 

It appeared to be an acknowledgement of US economic progress and perhaps the necessary first step on the path to a reduction of the $120 billion monthly bond program. Markets, however, were wary. The dollar and Treasury yields rose modestly and equities cut some of their losses at the release. The caution turned out to be well justified. 

By the time Fed Chair Jerome Powell had finished his news conference, any assumption that the initial taper discussion was near had vanished. The US economy might have improved but, according to Mr Powell, it was still far from the “substantial further progress” of the Fed’s guideline for a change in policy. 

Markets reversed, the small dollar and Treasury yield gains turned into losses and equities finished lower.  

This is how we covered it at the time, The FOMC  giveth and Powell taketh away

Economic data since the FOMC

Since the June 27-28  FOMC the labor market has continued to prosper. Nonfarm Payrolls (NFP) added 943,000  workers in July, which brought the two month average to 940,500, more than double the pace in April and May.  The unemployment rate dropped to 5.4% in July from 5.8% in June and the underemployment rate fell to 9.2% from 10%. All of these figures were considerably better than their forecasts. 

Jobs remained plentiful. The Job Openings and Labor Turnover Survey (JOLTS) rose to 10.07 million in July, the third all-time record in a row and nearly 800,000 more than June. 

JOLTS

FXStreet

Initial Jobless claims continued their slow descent from 400,000.

The economy seemed to be moving to a third excellent NFP report. The Fed was expected to have sufficient comfort with the recovery to begin the taper discussion at the Jackson Hole symposium, hosted by the Fed every summer in late August.

Suddenly, the University of Michigan Survey of Consumer Sentiment reported a precipitous drop in consumer optimism in August. The sentiment index plunged to 70.2 from 81.2. It was the weakest reading since 2011 and the third largest single month drop on record.   

Michigan Consumer Sentiment

FXStreet

Consumer Sentiment had been expected to be stable at 81.2 in August

Unexpectedly, the improvement of payrolls and employment was cast into doubt. 

Retail Sales in July were far worse than projected, falling 1.1% on a -0.3% forecast. The Control Group dropped 1%, also far beneath its -0.1% estimate.  Minor revisions to the June results, from 0.6% to 0.7% for the headline, and from 1.1% to 1.4% for control, did little to negate the dissapointment. 

For the consumer dependent US economy, if lower consumption persists for a few months it could short-circuit the entire recovery. 

FOMC minutes

The minutes are an integral component of Fed communication and will almost always elaborate on points raised by the statement or Chair Powell, but rarely present new information.  

Markets will be seeking clarification of the progress that the economy has made to the Fed’s goals and sense of how many governors were in favor of a quicker lift-off in rates.  

Conclusion

The pertinence of the FOMC minutes have been superseded by the Michigan sentiment number and the sharp dip in consumer spending. 

Even If the governors had discussed ending the bond program in the fourth quarter of this year or the first quarter of next, that was before Retail Sales declined in July and  sentiment plunged off a cliff in August.  

The rise of Covid-19 cases in the time since the July FOMC meeting and the continuing high inflation are the likely culprits behind the plunge in Consumer Sentiment and spending.

Whether the plummet in consumer outlook is a temporary reaction to the pandemic and inflation, or the beginning of a period of weakening consumption is unknown, but until the Fed has an answer, changes in rate policy are on hold. 

About 70% of US economic activity is tied to consumer spending.  If domestic consumption falls while inflation remains high, it creates a painful dilemma for the Fed. 

Raise interest rates to quell inflation at the cost of growth and job creation or remain accommodative and exacerbate inflation but support GDP and hiring. 

If the Fed has to choose between inflation and job creation, it will choose the latter every time.