Surveys suggest that a little more than 80% of the economists expect the Federal Reserve to hike rates in September. The September Fed funds futures, the most direct market instrument, has only about a 50% chance discounted. This week's FOMC meeting is the last one before September. The economy is performing largely in line with the Fed's expectations. Investors may be looking in vain if they expect some hint from the FOMC that it will in fact hike rates in September. It is more reasonable to expect a non-committal statement on the timing of the liftoff, as Yellen was in her recent Congressional testimony.
The Fed diligently worked to shift the focus of the outlook of policy from a date-specific commitment to a data-dependent path. A signal of a September rate hike would bring investors back to thinking about the date and unwind the Fed's efforts. This is unlikely. There are still much economic data to be released, including two employment reports. Also in the coming weeks, there will be a greater sense of the economic performance for the first couple of months of Q3.
The day after the FOMC meets, the US will publish its first estimate of Q2 GDP. The Atlanta Fed says it is tracking about a 2.4% annualized pace. We suspect the risk is on the upside. Economists may take advantage of the June durable goods orders report to tweak their forecast.
We know that Boeing orders jumped to 161 in June from 11 in May.This bodes well for headline orders, which may rise 3.2%-3.5% after a 1.8% decline in May. The details, especially the orders and shipments for nondefense and non-aircraft durable goods, should point improving business investment, and better overall growth.
Annual benchmark GDP revisions will also be announced. With new seasonal adjustments, the biggest impact is likely not to be so much on growth itself, but how it is distributed between the quarters. There is some risk that the first quarter may be revised up, but this may take from Q2. The precise details are unlikely to be particularly salient in considering the trajectory of monetary policy.
The Employment Cost Index (ECI) will be released at the end of the week. It is a measure of labor costs that Fed officials have cited on occasion. Every measure has strengths and weaknesses of course. The ECI uses fixed weights for individual industries and occupations. It has posted a quarterly average increase of 0.65% over the past year. It has averaged 0.51% over the past three years. It is expected to have risen 0.6%-0.7% in Q2, which would keep the year-over-year pace near 2.6% as it was in Q1, which is the fastest since 2008.
Fed officials, including Yellen, who is one of the foremost labor economists, understand that headline inflation converges to core inflation, and core inflation, in turn, is driven by labor costs. They are confident that as the labor market tightens there will be upward pressure on wages. Provided the labor market tightens, the Fed will be “reasonable confident” that its medium-term inflation target will be reached.
