The Federal Open Market Committee (FOMC) is widely expected to keep interest rates unchanged in August but attempt to prepare the public and markets for another rate hike in September. The vote next week will be unanimous. Look for the official statement to acknowledge the strength of the economy and inflation, both of which have picked up considerably since the start of the year. Second quarter GDP growth is expected to show a nearly 5% increase when it is released on Friday. Consumer spending, federal spending, inventory rebuilding (some in anticipation of tariffs) and investment gains all contributed to the acceleration in growth. The only soft spot may be housing, which is starting to show the strain of rising mortgage rates and home prices.
The pace of inflation has picked up with prices in energy and services. Medical costs are accelerating after decelerating in recent years. The transitory factors pointing to slower inflation, cited by former Fed Chair Janet Yellen last year, have played out; one was a glitch tied to falling prices of smartphone use.
The Fed is looking for ways to better communicate intent. Look for Chairman Jay Powell to hold off on any major changes for now. Changes could be made in how the Fed talks about the inflation target and the “dot plot,” which provides a sense of where individual participants believe the economy and rates will move.
There could be some acknowledgement of the uncertainty raised by tariffs. So far, Powell has shown himself to be politically savvy by noting the potential damage tariffs could do, but not acknowledging any effects. He has gone out of his way to argue that the Fed has no say on tariffs because the executive branch has authority on trade decisions. This has so far helped him avoid making the Fed a bigger target for politicians.
That said, the Fed cannot escape the inevitable. Every administration and Congress eventually become irritated with the central bank for removing the punch bowl just when the party gets going. Powell, however, now has strong allies on the Federal Reserve, which could help shelter him from political interference in raising rates, at least in the near term. Powell has been with the Federal Reserve since 2012 and understands well the need to maintain independence.
Many presidents have either overtly or covertly attempted to change the views and actions of the Fed. Few have succeed; when they did, the results were disastrous for the economy. President Truman went after the Federal Reserve to keep rates low and fund both the debt left from WWII and later the Korean War. Nixon pressured Fed Chairman Arthur Burns into easing, in an effort to ensure his reelection in 1972. Both episodes resulted in rising inflation that eroded purchasing power.
For now, look for Powell to stay the course, continuing to signal and execute on rate hikes. He cannot be fired and has enough loyal allies on the Federal Reserve to carry out his mission and remain independent of political interference. The risk lies in who is nominated to fill the remaining two governor seats on the board and how rapidly they can be brought on board. The bet is that the nomination and confirmation of the last two Fed governors will be a slow process.
Copyright © 2018 Diane Swonk – All rights reserved. The information provided herein is believed to be obtained from sources deemed to be accurate, timely and reliable. However, no assurance is given in that respect. The reader should not rely on this information in making economic, financial, investment or any other decisions. This communication does not constitute an offer or solicitation, or solicitation of any offer to buy or sell any security, investment or other product. Likewise, this communication serves to provide certain opinions on current market conditions, economic policy or trends and is not a recommendation to engage in, or refrain from engaging, in a particular course of action.