Optimism over labour market and growth clear; inflation expected to return to target.
The April/ May FOMC meeting saw the Committee hold firm to their constructive but cautious view of the economic outlook. That inflation’s underperformance of the 2.0%yr medium-term target was highlighted in the decision statement initially supported market pricing of rate cuts in late-2019 and 2020. However, in the press conference Chair Powell subsequently made clear that this miss is regarded by the Committee as transitory, and hence is of no consequence for policy.
On activity, the decision statement continued to characterise the labour market as strong – a view we wholeheartedly agree with given the 180k month-average gain of 2019 is consistent with a further decline in the unemployment rate from its already historically-low level of 3.8% towards 3.5%.
With respect to GDP growth, the change in the wording of the statement from “growth of economic activity has slowed from its solid rate in the fourth quarter” to “economic activity rose at a solid rate” is also positive, pointing to a belief that the March quarter deceleration in domestic final demand will prove temporary. Justifying this view, Chair Powell emphasised in the press conference that the partial data for consumption and business investment had picked up of late.
This commentary indicates that the FOMC’s view on domestic final demand is as robust as their overall GDP forecast from the March 2019 meeting – an above-trend 2.1% gain expected in 2019 – despite the soft March quarter detail.
Although it received little attention in today’s communications, it should also be noted that risks associated with financial conditions and the global economy have also dissipated in recent months.
Most notably, households have received twin-benefit from the marked reduction in the US 10-year yield (which determines the 30-year mortgage rate) from a high of 3.26% to 2.50% currently and the related strong rally in equity markets.
For business, there is also cause to be more comfortable over the outlook, with trade negotiations between China and the US remaining constructive and the IMF pointing to still-robust growth in the global economy over 2019 and 2020. Both views are in line with our own expectations.
With regards to inflation, the Committee’s decision statement certainly showed more concern, with core PCE inflation (excludes food and energy) said to have “declined” to now be “running below 2 percent”.
However, in the subsequent press conference, Chair Powell repeatedly made clear that core PCE inflation’s unexpected weakness was believed to be transitory and hence of no significance for the stance of policy for the foreseeable future.
Primary justification for confidence in the outlook for core inflation came from the Dallas Federal Reserve’s trimmed mean measure holding at 2.0%yr despite the PCE exclusion measure having fallen to just 1.6%yr. Chair Powell went on to highlight that the disinflation reported by core PCE came from a number of one-off transitory factors as was the case in 2017 – after which core inflation rose to be in line with the medium-term target in 2018.
Looking ahead, we believe the underlying macroeconomic picture is supportive of core PCE inflation again returning to target. As above, momentum in the labour market remains robust and is set to sustain the wage growth uptrend of recent years. Along with above-trend activity growth, this momentum in wages should see underlying consumer inflation strengthen.
This view does not however mean that we foresee the FOMC turning hawkish. After years of inflation underperformance, with activity growth slowing back towards trend, and given global risks are still tilted to the downside, further rate hikes would only be warranted if inflation materially surprised to the upside over a protracted period.
We continue to see little risk of such an outcome and therefore of the FOMC doing anything other than remaining on hold for the foreseeable future – through both 2019 and 2020.
