Inflation Nation July 2017 Fed Preview
Tomorrow the Fed will convene for their July meeting, this time with little fanfare. Unlike in June, there are no expectations of any policy shifts or rate changes. No post meeting press conference is scheduled, nor are there any new economic forecasts releases. After two highly anticipated rate bumps earlier this year, this meeting seems mundane. No surprises are expected this week, but that being said, the devil is always in the details when it comes to parsing the meeting’s closing statement.
Balance Sheet:
Earlier this year the Fed hinted it might move away from quantitative easing, a policy that saw the Fed’s balance sheet rise from $0.9 trillion to $4.4 trillion since 2007. Any plan to reverse this policy would signal that the Fed is increasingly comfortable that economic growth is returning to a more normal, predictable, and sustainable trajectory. Quantitative Easing’s aim was to boost market liquidity through the purchase of securities to stimulate lending, and thus help mitigate lingering effects of the recession.
Experts are divided on the expect effects of the reduction, some believing that economic conditions do not yet warrant a move away from stimulative policy. They do not believe that the current economic conditions are sufficient and the combination of planned interest rate hikes along with a reduction could stagnate the sluggish economic growth that exists and could potentially lead to a recession.
As this year’s rate action clearly demonstrates however, the Fed is increasingly comfortable with current economic trends, making such a reduction both timely and desirable.
This chart, published by the Federal Reserve Bank of New York, showcases the Fed’s 5-year plan to begin reducing its balance sheet.
These have been extraordinary years, however, with few historical precedents to serve as a reliable guide. Many expect the reduction to begin sometime in September and will be reading tomorrow’s tea leaves looking for confirmation. Watch for any language that may indicate a switch to a more aggressive or conservative approach.
Interest Rates:
The Fed is not expected to raise interest rates tomorrow, nor is it expected to announce timings to do so. Last year, the Fed announced plans to raise rates three times in 2017 and thus far only two have come to fruition. However weak inflation numbers may change their initial plans.
Inflation:
Key language to look for tomorrow will be the Fed’s comments regarding inflation. According to personal-consumption expenditures price index, one of the Fed’s preferred metrics, inflation has underperformed the Fed’s 2% target the past three months. As rate increases typically reduce inflation, these statistics create doubts on whether the Fed should continue hiking rates, a move that under the wrong conditions could slow growth. Last month Fed Chair Janet Yellen stated “The recent lower reading on inflation have been driven significantly by what appears to be one-off reductions in certain categories of prices such as wireless telephone services and prescriptions drugs” indicating her belief that the low inflationary conditions were created by temporary factors and that interest rate hikes would continue as planned. She has since walked that back somewhat, stating that Fed officials have been paying more attention to low inflation readings. What Yellen says about inflation in the upcoming meeting may indicate how the Fed will proceed in regards to its monetary policy, rate hikes and balance sheet reduction, during the upcoming months.
Expect the Fed to acknowledge weakening inflation during its statement tomorrow. However, expect Yellen to keep to her plan to raise interest rates once more during 2017, although it may take until December to be realized.
-Thomas Henning
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