Fed Holds Rates Steady but Several Members Dissent

Fed Decision & Market Impact

The July Federal Reserve (Fed) meeting concluded this week with the decision to leave the benchmark Fed Funds Rate unchanged. Interestingly, there were three members that dissented, wanting to raise the rate. They spoke later in the week clarifying their reasoning, which caused a bit of market volatility, keeping mortgage rates at recent highs. 

Fed Communications and Guidance

Chairman Kevin Warsh continued to be tight-lipped on future guidance-projecting what the Fed is likely to do in the future. He is clearly waiting for the results of his task forces, one of which is addressing exactly this issue: communications.

He emphasized that the Fed remains committed to bringing inflation back to its 2% target, while making it clear the Fed won’t signal its next move ahead of time. He stressed that the Fed wants financial markets to respond to real economic developments rather than speculation about future Fed policy. 

He stated, “Market participants are learning to play the ball, not the referee,” adding that the Fed doesn’t need to be the center of attention if markets are reacting appropriately to the data.

Beth Hammack’s Inflation Concerns

One of the dissenters was Cleveland Fed President, Beth Hammack. She explained that she believes inflation has remained too high for too long and is not confident it will return to the Fed’s target on its own. She said she sees inflation coming from supply-side factors, like energy prices, but also from higher demand, suggesting consumers continue to spend. 

In the same statement, she also states that many people are struggling financially. This raises questions about the strength of consumer demand. She has previously suggested that both higher and lower oil prices can contribute to inflation. These statements seem to be contradictory.

Neel Kashkari on Supply Shocks

Another one of the dissenters is Minneapolis Fed President, Neel Kashkari. He said that he feels inflation has come from a series of supply shocks, like the war in Ukraine, trade wars, and the conflict in the Middle East. He acknowledged that the Fed needs to look through these shocks. He sees a risk to inflation becoming entrenched and he felt “a strategy of small policy steps would allow the FOMC (Federal Open Market Committee) to slow or pause subsequent adjustments without unnecessary impact on the real economy.”

Dallas Trimmed Mean PCE Results

Chairman Warsh has stated several times his focus on the Dallas Fed Trimmed Mean Inflation report as a better metric than the Core PCE. The third dissenter was Dallas Fed President, Lorie Logan, whose bank produces this report. This report was released for the month of June this week. Unlike Core PCE, it removes the top 31% and bottom 24% of inflation categories to eliminate volatility and focus on sustained price changes. This report showed annual inflation at 2.2%, down from 2.4% in May. This confirms that inflation is headed in the right direction.

Employment Cost Index Update

Former and second-longest serving Fed Chairman, Alan Greenspan’s favorite measure of inflation is the Employment Cost Index.  This measures inflation through the cost of employment. This report showed the index overall held steady at 0.9% in Q2. This is one tenth above estimates and supports low wage-pressured inflation. Again, this would support less of a need to raise rates to combat inflation.

June PCE Inflation Report

The June Personal Consumption Expenditures (PCE) inflation report was released this week. It showed headline inflation fell to 0.1% and yearly fell from 4.1% to 3.7%. These were as markets estimated. The core reading, stripping out food and energy, rose 0.1%, slightly lower than estimated. Yearly, core PCE fell from 3.4% to 3.3%. That is a big difference from the 2.2% shown in the Dallas Fed Trimmed Mean PCE. 

Upcoming PCE Methodology Changes

The Bureau of Economic Analysis (BEA) reported that the PCE has announced it will be changing the methodology for several components starting with their August report that releases in September. This includes legal services, computer software and accessories, and, as we have repeatedly discussed, portfolio management. 

Currently, if the value of portfolios increases due to improving investments, the higher fees earned by advisors are treated as inflationary. This is true even if the percentage earned decreases, if the dollars received increases, it is inflationary. It doesn’t make sense that this would be inflation. It is a good thing for portfolios to grow, and consumers are happy to pay more as a result.  Portfolio management has contributed to PCE readings but as much as 0.4%, so this isn’t insignificant. 

Q2 GDP First Look

Quarter 2 Gross Domestic Product (Q2 GDP) had its first estimate released. It is called its “first look.” It showed GDP rose at an annual rate of 1.5%. This was weaker than expectations of 2%. It follows a 2.1% reading in Q1.

Looking Ahead: There’s Another Federal Reserve Meeting Next Week

• Monday, July 27: Durable Goods Orders
• Tuesday, July 28: ADP Weekly, Case-Shiller and FHFA appreciation reports
• Wednesday, July 29: Fed Meeting results
• Thursday, July 30: Personal Consumption Expenditures, Q2 GDP, Jobless Claims
• Friday, July 31: Employment Cost Index