On July 31, the Federal Reserve Board will announce their decision on interest rates. Simply put, the market is pricing in a 25 basis point reduction to the federal funds rate. Ever since Federal Reserve Chairman Jerome Powell gave remarks hinting that the Fed was prepared to pursue a more accommodative policy, the market has been climbing. Two days after Chairman Powell’s testimony before Congress, the Dow Jones Industrial Average, NASDAQ, and S&P 500 all closed at record highs.
The era where good news is bad …
We are in an economic climate where an employment report that shows the economy created 224K jobs as opposed to the forecast for 160K jobs can revive speculation that good economic news is bad news for the market. Still, the pullback was based on light volume and the market, as the next week proved, shrugged off the bad news and kept marching forward.
… and bad news is good
The market is also largely ignoring the ongoing stalemate with China on trade policy. This may change as companies report second-quarter earnings. It is anticipated that many companies which had delivered forward guidance in the first quarter based on the anticipation of a deal would now factor in a protracted trade war – and adjust their guidance accordingly. This would be good news for the interest rate cut bulls who have already expressed concern that the ongoing malaise in global equity markets would soon spread to the United States.
The only thing that may be able to slow down the momentum for a rate cut would be significantly better than expected news from economic indicators that will be released before the Fed’s meeting. With that in mind, the three reports you should be paying attention to are the Retail Sales Report, the Preliminary GDP Report, and the Personal Consumption Expenditure (PCE) Report.
Will the Fed ignore strong retail sales?
The Commerce Department released its Retail Sales Report on July 16, showing that retail sales rose 0.4% in June, the fourth consecutive month of increases. The report, which combines online as well as brick-and-mortar sales, is a key metric for the Fed because it underscores the importance of consumer spending to the U.S. economy. Retail sales count for approximately one-third of all consumer spending.
In a research note that accompanied the report, Ksenia Bushmeneva, an economist at TD Economics said, “The onus falls on American consumers to drive economic growth…It seems they are up to this task.”
The consumer seems to be continuing to spend despite the rising costs of some consumer goods caused by tariffs. Modest wage increases and higher employment numbers also may be helping to propel consumer confidence as the stimulus from the Trump administration tax cuts begins to fade.
Will the Fed look at GDP now or in the future?
The second report that investors should pay close attention to is the preliminary GDP estimate, which will be released on Friday, July 26. This report is not expected to be a showstopper with many analysts forecasting a number between 2.75% and 3.25%. If that’s the case, it would put the report solidly in line with the consensus 3.0% GDP forecast. What will be more intriguing, however, is any foreword guidance that the report provides. GDP is considered a leading indicator of a country’s economic health. The conventional wisdom is that the economy will have sustained weakness in the second half of 2019. That would be a signal to the Fed that an interest rate cut, while perhaps not absolutely necessary, could be a pre-emptive strike.
Does the Fed want more inflation?
Finally, the day before the Fed’s decision, investors will get to digest the Personal Consumption Expenditure (PCE) report. This will give the market an inflation reading. If the rate comes in at its expected rate of 1.5% (the Fed’s target rate for inflation is 2 percent), it would be seen as good news for the market. The stubborn lack of inflation is a problem that central banks around the world are grappling with. David Wessell, the Director of the Hutchins Center at the Brookings Institution had this to say about why the Fed might be concerned about low inflation. “One possibility is that the economy isn’t nearly as close to full employment as the experts say – that there were enough people on the sidelines of the economy, who are now starting to look for work, that employees still don’t have to give very many wage increases.”
Will any of this matter for the Fed?
Despite economic reports that may suggest the Fed would be justified in holding interest rates where they are, the Fed is under pressure from the markets and the current administration to cut rates and provide stimulus to the market. In fact, as we move into the dog days of summer and its lighter trading volume, the Fed and their decision on interest rates is the only story that will give the markets any traction. Unless the consumer numbers absolutely blow away the Federal Reserve Board of Governors you should expect a rate cut and position your portfolio accordingly.