Natixis on FOMC Rate Decision - FJElite
We continue to see the Fed embarking on an extended hold. We are cautiously optimistic about the trajectory of inflation as the primary drivers of recent years (namely hot wage growth and housing inflation) look set to cool off in the coming quarters. We also think that the labor market, while stable, will not provide an inflationary impulse. That said, most standard Taylor Rules would suggest that a hike is currently required.
The question for us is a) how quick and steady will the disinflationary process be and b) what will the Fed’s reaction function be if progress is not fast enough. We think in the near term the onus will be on further subdued inflation readings for the Fed to avoid a hike, and that is indeed our call. We view the June inflation readings as being anomalous in their magnitude (being well below consensus) but not in their signal (that progress towards 2% is underway). The possibility of another round of tariffs or yet another leg up in energy prices from the failed MOU with Iran are both significant risks to our outlook.
Should near-term inflationary prints surprise to the upside - or even just remain stubbornly high - Warsh will likely feel the need to increase the policy rate to follow through on his perceived promises to bring inflation back down quickly. In that instance, if he doesn’t increase rates, he may jeopardize his own credibility. Though he has frowned upon depending on backward-looking data, he may need to increase restrictiveness to avoid getting caught in his own credibility trap.
On the flip side, if we are correct about reduced domestically generated price pressures, the Fed could avoid hikes in the near term. And should consumption slow as we are forecasting, the odds of a reduction in the Fed’s policy rate increase, but this scenario would likely not be apparent until next year.
