Looking ahead to this week's FOMC meeting

Monday, 17th June 2019 08:07 - by Shant

In what looked to be a series of pretty steady rate-setting meetings at the Federal Reserve this year, US politics have cranked up the pressure on policymakers as White House trade policy is really starting to concern economy watcher and the impact on the US consumer as a primary driver going forward. 

As we saw in the Q1 data, there were some telltale signs that manufacturers and wholesalers are stocking up on inventory, in preparation for a long drawn out trade war which President Trump is choosing to wage on a number of fronts, with China being his primary target.   While the president is prepared to play the long game, so it seems, is China, and the Fed is clearly wary of this and how it may affect the economy going forward.  

If there were any doubts, then the bond markets have provided them with a clear view of what they thinking, sinking 10yr yields down to within 10bps of the 2.0% mark, which is currently providing some support but still very much under pressure.  This curve inversion has prompted calls for the Fed to cut rates sooner rather than later, and aggressive calls are being made to the tune of 50bps in the July meeting - so the rhetoric next week (when they meet next) will be crucial for equity markets given recent gains have been significantly powered by these dovish expectations.  As such, there is plenty of pressure in chairman Powell to deliver a message (at the very least) which could placate markets across the spectrum.  As we have seen in previous meetings, a failure to offer up an accommodative stance in these uncertain times can have a volatile effect on equities, and we suspect it will be more of the same unless the door is left open to potential easing.  

One has to feel for Chairman Powell in this context.  One the one hand, he has a president who is aggressively driven to attaining progress on trade at whatever cost, prompting uncertainty within the domestic economy.  The prior narrative that tariffs will cause external pressures has now faded as the signs are clearly showing.  However, in terms of employment and inflation - the 2 mandates on which Fed policy is shaped - are holding up. We are still at multi-year lows on unemployment, and even though wage growth is tepid, the Fed has acknowledged the healthy economy in its current state.  Inflation is close to target also, yet with fiscal stimulus having worked its way through the system, the White House is now counting on the Fed to provide a further boost to the economy.  

If it does, however, then its credibility will be called into question.  Cutting rates at a time when Wall Street indices are trading close to record highs sends all the wrong signals, and this may sound somewhat counter-intuitive, will also undermine the stock markets in the long run.  As it currently stands, market participants have acknowledged the strong dependency on easy financial conditions.  While the Fed has room to cut, the normalisation process was and is designed to act as a buffer for the next economic downturn.  While odds of a recession are some way deep into 2020, acting now may be justified by some, but acting too soon could also potentially reflect some panic on the US front.  

As we saw in the May reading, job gains in the US were some way off the longer run average at just 75,000, but this is no major cause for concern at this stage.  This week, we saw consumer spending returning with a vengeance, rising 0.5% in May while the negative readings in April were all revised into positive territory.  To boot, we also saw industrial production returning the month with a 0.4% rise, so the real economy does not seem to warrant any accommodative action at this stage.  So the question is, how will stock markets contend with an ongoing wait and see approach?  Well, we will find out next week, but if the perceived drivers have been expectation and hope, then Wall Street is in for a surprise - and not a pleasant one.  Meanwhile, Gold prices are heading higher - watch that one!

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.