Fed Decision Looms as Inflation Eases and Growth Surprises
US economy at crossroads: election, FOMC, global health impact on growth, inflation, financial stability. Forex traders to watch for volatility.
Saturday, 27th July, Week 30
Uncle Sam's Balancing Act: Fiscal Policy in Focus
The US fiscal policy landscape has been relatively stable over the past five months, marked by ongoing efforts to reduce the budget deficit. The Fiscal Responsibility Act of 2023, signed into law in June, aims to achieve deficit reduction through spending cuts and revenue increases. This legislation, combined with the deficit-reducing measures in the Inflation Reduction Act, underscores a commitment to fiscal responsibility. The current fiscal policy can be characterised as focused on balancing investments in key areas like infrastructure and clean energy with efforts to address the budget deficit. Looking ahead to the next five weeks, fiscal policy is likely to remain in the spotlight as the Presidential Election approaches. The outcome of the election could significantly impact future fiscal policy decisions, with potential shifts in spending priorities and tax policies depending on which party gains control of the White House and Congress. Fiscal policy plays a crucial role in shaping the overall economic landscape, influencing interest rates, inflation, and economic growth. Forex traders should closely monitor developments in fiscal policy, particularly any potential shifts in the post-election period, as these changes can have significant implications for currency valuations. The 2025 Budget "reduces the deficit by another $3 trillion over the next 10 years as well, while continuing to pay for our investments in America."
American Exceptionalism: A Strong Economy Faces Headwinds
The US economy has demonstrated resilience over the past five months, continuing to expand despite elevated interest rates. The second quarter of 2024 saw a robust annualised GDP growth rate of 2.8%, exceeding forecasts and highlighting the strength of consumer spending and business investment. The labour market remains strong, with solid job gains and a low unemployment rate, although there are signs of gradual cooling as demand and supply move into better balance. Inflation has eased considerably from its peak, with the annual inflation rate falling to 3% in June, the lowest since June 2023. Despite this positive momentum, the economic outlook for the next five weeks and beyond is clouded by uncertainty surrounding the upcoming Presidential Election and the potential for policy shifts. The outcome of the election could significantly impact economic sentiment, business investment, and consumer spending, potentially influencing the pace of economic growth in the coming months. The strength of the US economy is a key factor driving the value of the dollar. Forex traders should closely monitor economic indicators for signs of sustained growth, as well as any potential shifts in the post-election period, as these developments can have a significant impact on currency valuations.
Economic Growth:
GDP Growth Rate QoQ Adv Q2: 2.80%, up from 1.40% in Q1, exceeding forecasts of 2%. The second quarter growth was driven by consumer spending, private inventory investment, and nonresidential fixed investment. The outlook for the next five weeks and beyond will depend on the outcome of the Presidential Election and its impact on economic sentiment and business investment.
Durable Goods Orders MoM JUN: -6.60%, missing market expectations of a 0.3% increase. The decline was driven by a sharp drop in transportation equipment orders. The outlook for durable goods orders in the coming weeks will be influenced by business confidence and investment plans in the face of potential policy changes after the election.
Chicago PMI JUL: 47.4, beating forecasts of 40 but remaining in contraction territory for a seventh consecutive month. The outlook for the Chicago PMI in the coming weeks will depend on manufacturing activity and new orders, which could be influenced by election-related uncertainty.
Price Changes (Inflation):
Inflation Rate YoY JUN: 3%, down from 3.3% in May and below forecasts of 3.1%. The decline in inflation was driven by easing energy costs and a slowdown in shelter price increases. The outlook for inflation in the coming weeks will depend on energy prices, housing costs, and the impact of the election on consumer and business expectations.
Core Inflation Rate YoY JUN: 3.30%, down from 3.4% in May and below market forecasts of 3.4%. The decline in core inflation was driven by easing shelter costs and a slowdown in motor vehicle insurance price increases. The outlook for core inflation in the coming weeks will depend on housing costs, medical care costs, and the impact of the election on consumer and business expectations.
Core PCE Price Index MoM JUN: 0.20%, above market expectations of a 0.1% increase. The increase in core PCE prices was driven by a rise in prices for services. The outlook for core PCE prices in the coming weeks will depend on service sector inflation and the impact of the election on consumer and business expectations.
Labour:
Non Farm Payrolls JUN: 206K, beating forecasts of 190K but slowing from a revised 218K in May. The outlook for nonfarm payrolls in the coming weeks will depend on the pace of economic growth and the impact of the election on hiring decisions.
Unemployment Rate JUN: 4.10%, matching the rate in May and exceeding forecasts of 4%. The outlook for the unemployment rate in the coming weeks will depend on the pace of job creation and the size of the labour force, which could be influenced by election-related uncertainty.
Initial Jobless Claims JUL/20: 235K, below market expectations of 238,000. Initial jobless claims have remained above this year's average, indicating a softening in the labour market. The outlook for initial jobless claims in the coming weeks will depend on labour market conditions and the pace of layoffs, which could be influenced by election-related uncertainty.
Housing:
Housing Starts JUN: 1,314,000 (annualised rate), rebounding from a revised 4.6% decline in May and exceeding market expectations of 1,300,000 starts. Housing starts have been volatile in recent months. The outlook for housing starts in the coming weeks will depend on mortgage rates, housing affordability, and the impact of the election on homebuyer sentiment.
Existing Home Sales JUN: 3.89 million units (annualised rate), falling for a fourth consecutive month and marking the sharpest monthly decline since 2022. The outlook for existing home sales in the coming weeks will depend on mortgage rates, housing affordability, and the impact of the election on homebuyer sentiment.
NAHB Housing Market Index JUL: 42, the lowest level in the current year and below market expectations of 44. The decline in homebuilder sentiment was driven by expectations of higher interest rates for longer. The outlook for the NAHB Housing Market Index in the coming weeks will depend on mortgage rates, housing affordability, and the impact of the election on homebuilder sentiment.
Business Confidence:
ISM Manufacturing PMI JUN: 48.5, below forecasts of 49.1 and pointing to a third straight month of falling manufacturing activity. The manufacturing sector has been in contraction for three consecutive months. The outlook for the ISM Manufacturing PMI in the coming weeks will depend on demand, output, and new orders, which could be influenced by election-related uncertainty.
Philadelphia Fed Manufacturing Index JUL: 13.9, the highest level in three months and exceeding forecasts of 2.9. The outlook for the Philadelphia Fed Manufacturing Index in the coming weeks will depend on general activity, shipments, new orders, and employment, which could be influenced by election-related uncertainty.
Dallas Fed Manufacturing Index JUL: -15.1, up from a four-month low of -19.4 in May. The outlook for the Dallas Fed Manufacturing Index in the coming weeks will depend on production, new orders, capacity utilisation, and shipments, which could be influenced by election-related uncertainty.
Consumer Sentiment:
Michigan Consumer Sentiment Final JUL: 66.4, the lowest in eight months. The outlook for consumer sentiment in the coming weeks will depend on inflation expectations, personal finances, and the outcome of the Presidential Election.
CB Consumer Confidence JUL: 100.4, exceeding forecasts of 100. The outlook for consumer confidence in the coming weeks will depend on labour market conditions, inflation expectations, and the outcome of the Presidential Election.
RCM/TIPP Economic Optimism Index JUL: 44.2, the highest level in six months and exceeding forecasts of 41.2. The outlook for economic optimism in the coming weeks will depend on the six-month economic outlook, personal financial outlook, and confidence in Federal economic policies, all of which could be influenced by the Presidential Election.
Trade:
Balance of Trade MAY: -$75.1 billion, the largest since October 2022 and below forecasts of a -$76.2 billion gap. The trade deficit has been widening in recent months. The outlook for the trade balance in the coming weeks will depend on the strength of the dollar, global demand, and trade policies, which could be influenced by the outcome of the Presidential Election.
Exports MAY: $261.7 billion, down 0.7% from April and below forecasts of $265 billion. The outlook for exports in the coming weeks will depend on the strength of the dollar, global demand, and trade policies, which could be influenced by the outcome of the Presidential Election.
Imports MAY: $336.7 billion, down 0.3% from April and below forecasts of $341 billion. The outlook for imports in the coming weeks will depend on domestic demand, the strength of the dollar, and trade policies, which could be influenced by the outcome of the Presidential Election.
The Fed's Tightrope Walk: Monetary Policy in the Balance
Over the past five months, the Federal Reserve has maintained a restrictive monetary policy stance, holding the target range for the federal funds rate steady at 5¼ to 5½ percent. The current monetary policy can be characterised as data-dependent, with the Fed closely monitoring economic indicators to assess the appropriate path for interest rates. The outlook for monetary policy over the next five weeks is dominated by the upcoming FOMC meeting scheduled for Wednesday 31st July (Week 31). The Fed's decision at this meeting will depend on its assessment of the latest economic data, the evolving outlook, and the balance of risks. Market pricing currently suggests a high probability of a rate cut in September, but the Fed's communications have emphasised the need for patience in assessing the trajectory of inflation. The Fed's monetary policy decisions have a significant impact on the value of the dollar. A decision to cut rates could weaken the dollar, while a decision to maintain the current target range could support the dollar. Forex traders should closely monitor the FOMC meeting and any subsequent communications from Fed officials for clues about the future direction of monetary policy. As stated in the June FOMC minutes, "The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent."
Navigating the Minefield: Risks to the Economic Outlook
Past Risks (Previous Five Months):
Inflation Persistence (February - June 2024): Despite easing from its peak, inflation remained stubbornly high in the first half of 2024, exceeding the Fed's 2% target and raising concerns about potential wage-price spirals. This persistence fueled market volatility and uncertainty about the future path of monetary policy.
Core PCE inflation remained above 2% throughout the period.
The Fed maintained a restrictive policy stance.
Longer-term inflation expectations remained anchored but showed signs of vulnerability.
Commercial Real Estate Weakness (March - June 2024): The commercial real estate (CRE) sector has shown increasing signs of weakness in recent months, with rising vacancy rates, falling property values, and increasing loan delinquencies. This weakness has raised concerns about potential spillover effects on the broader economy and financial system.
The average CMBS delinquency rate rose to its highest level since 2021.
Credit quality deteriorated for CRE borrowers at banks.
Office, hotel, and retail sectors were particularly hard hit.
Presidential Election Uncertainty (May - July 2024): The approaching Presidential Election has injected a significant degree of uncertainty into the economic outlook, with potential policy shifts depending on the outcome of the vote. This uncertainty has weighed on business confidence and investment plans.
Polls showed a tight race between the two main candidates.
Businesses expressed concerns about potential changes in tax and regulatory policies.
Consumer sentiment remained subdued amid economic and political uncertainty.
Future Risks (Following Five Weeks):
FOMC Policy Disappointment (Week 31): The FOMC meeting on Wednesday 31st July (Week 31) could disappoint market expectations if the Fed signals a more cautious approach to rate cuts than currently anticipated. A less dovish stance from the Fed could trigger a sell-off in risk assets and strengthen the dollar.
China Economic Slowdown (August - September 2024): A sharper-than-expected slowdown in China's economy could have negative spillover effects on the global economy, potentially impacting US exports and commodity prices. A weaker Chinese economy could also weigh on global risk sentiment, potentially impacting US financial markets.
Conclusion: A Pivotal Period for the US Economy
The US economy is at a crossroads, facing a confluence of factors that could shape its trajectory in the coming weeks and months. The upcoming Presidential Election, the FOMC's policy decisions, and the health of the global economy will all play a crucial role in determining the outlook for growth, inflation, and financial market stability. Forex traders should closely monitor these developments and be prepared for potential volatility as the economic and political landscape evolves.
Key Events to Monitor:
FOMC Meeting: Wednesday 31st July (Week 31)
Non-Farm Payrolls: Friday 2nd August (Week 31)
ISM Manufacturing PMI: Thursday 1st August (Week 31)
CPI Inflation: Wednesday 14th August (Week 33)
Retail Sales: Thursday 15th August (Week 33)
Sources:
U.S. Bureau of Economic Analysis (BEA)
U.S. Bureau of Labor Statistics (BLS)
Federal Reserve
Trading Economics
S&P Global
Institute for Supply Management
National Association of Home Builders
Standard & Poor's
U.S. Census Bureau
National Association of Realtors
Federal Reserve Bank of New York
Federal Reserve Bank of Philadelphia
Federal Reserve Bank of Dallas
Federal Reserve Bank of Chicago
University of Michigan
Technometrica Market Intelligence/RealClearMarkets