July 2019 U.S. Economic Outlook

Robert A. Dye, Ph.D.

,

Daniel Sanabria

Federal Reserve Building

According to Homer, Scylla was a six-headed sea monster and Charybdis was a whirlpool.



Between Scylla and Charybdis (First Pass)

According to Homer, Scylla was a six-headed sea monster and Charybdis was a whirlpool. They occupied opposite sides of the Strait of Messina near modern Italy and are sometimes evoked when a person, or an organization, must navigate through a difficult passage. The Federal Reserve is on such an odyssey as it contemplates its next monetary policy move ahead of the July 30/31 Federal Open Market Committee meeting. 

Financial markets have been pushing hard on the Fed to begin easing monetary policy this year. The probabilities implied by the fed funds futures market for at least one 25 basis point rate cut this year are overwhelming. Pressure on the Fed is also coming from outside the U.S. Other central banks are easing. Mario Draghi, outgoing president of the European Central Bank has telegraphed what may be his final policy move before Christine Lagarde takes over (pending her final approval). With other central banks easing, the Fed will effectively tighten if it stands still and this would put pressure on the already strong dollar. 

The Fed’s “data dependence” is more complicated than ever. Recent U.S. data has been mixed. Job growth in May was soft, then it bounced back in June. Manufacturing indicators have been easing but auto sales were surprisingly strong in May and June. Global growth has cooled, in part due to international trade uncertainties. However, trade wars could be resolved quickly, or they could linger for years, if not decades.

The other dimension of the Fed’s data dependence is also ambiguous. In his speech at the Fed’s annual symposium in Jackson Hole last August, Fed chair Jay Powell noted the data “stars” by which the Fed navigates. R-star is the neutral rate of interest. Pi-star is the inflation objective. U-star is the natural rate of unemployment. A year later we wonder whether those stars are fixed beacons, or do they drift? The upcoming Jackson Hole Conference may provide more clues about how the Fed views its guiding stars. 

Political pressure on the Fed by the Trump Administration has been intense, compounding the potential for a lose-lose-lose-lose policy announcement by the Fed on July 31. With respect to interest rates, the Fed has four choices in front of it. The first possible outcome is that they raise the fed funds rate by 25 basis points. This is a very low probability event and would instantly trigger a financial market reset and intense pushback from many directions. The next choice is to do nothing with interest rates. The probability of doing nothing is also low, but it is higher than the zero probability assigned to it by the fed funds futures market. Again, the Fed would be courting financial market volatility and intense pushback if they leave the fed funds rate unchanged. The third option is to lower the fed funds rate by 25 basis points. This is not a win for the Fed in terms of financial market reaction because that move is already priced in. Further, it would disappoint those who favor a stronger move by the Fed. The fourth option is a 50 basis point rate cut. This would give the strongest jolt to the economy, and likely win praise from interest rate doves. But the Fed would risk using up a big chunk of its rate cutting potential for an uncertain upside gain at a time when the data is ambiguous. 

We believe that the Fed’s least bad policy choice is to make a 25 basis point rate cut at the end of July and then do nothing through at least the next FOMC meeting (over September 17/18) in order to gauge the response of the economy to marginally lower interest rates. A key risk of the least bad move is that a 25 basis point reduction at the end of July is not enough and leaves the Fed in a position later this fall that is similar to where it is right now. 

For a PDF version of this report, please click here: July 2019 U.S. Economic Outlook.



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July 8, 2019
Robert A. Dye, Ph.D., Senior Vice President and Chief Economist at Comerica Bank

Robert A. Dye, Ph.D.

Senior Vice President and Chief Economist
Daniel Sanabria, Senior Economist at Comerica Bank

Daniel Sanabria

Senior Economist

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