The data this week is expected to confirm what many investors have come to assume. The US economy accelerated in Q2. The eurozone economy is enjoying steady growth, but the momentum appears to be slowing. The UK economy was unable to recover much after a soft Q1. The Japanese economy is still not generating price pressures, but growth, led by the export/industrial production capex, is also fueling somewhat better consumption.
The Federal Reserve meeting is not live in the sense that anyone expects a change in the policy of any kind. For reasons beyond our ken, the Federal Reserve insists on making changes only at the half of the FOMC meetings which are followed by a press conference. Since there are several workarounds, including, as we have suggested, holding press conferences after every meeting, which the ECB and BOJ already do, for example.
In any event, the market understands full well where the Fed is. It is getting close to allowing its balance sheet to begin shrinking. After raising rates in March and June, officials are not ready to go again: Not in July and not September. December is a closer call. The softer price pressures rather than, the weaker growth impulses become the focal point in Q2. It will take a few months of data to assuage these concerns. The main argument that what the headwind on prices is transitory seems to assume that decline in prices is narrow. Breadth indicators of price changes, therefore, be more important than usual in the current context. Sure enough, the diffusion indicators for the CPI were narrow, until the recent June reading.
When the balance sheet issue was being discussed, NY Fed President Dudley suggested that the central bank may have a brief pause in its efforts to normalize the Fed funds target rate around the time that it decides to begin allowing the balance sheet to shrink. This still seems the most likely scenario. Given the apparent consensus to begin not reinvesting in full the proceeds from maturing issues sooner rather than later, the September FOMC meeting is a compelling venue to make such an announcement. Deferring a rate decision until the December meeting, by which time the inflation picture may clarify, seems prudent.
