Weak job and inflation data complicate Fed’s rate decision

The Federal Reserve is getting plenty of advice as its policymaking committee prepares to meet today and Wednesday amid expectations that the central bank will lift interest rates by a modest quarter-point.

The Federal Reserve is getting plenty of advice as its policymaking committee prepares to meet today and Wednesday amid expectations that the central bank will lift interest rates by a modest quarter-point.

Recent developments that could nudge the Fed away from a rate increase include weak May job growth (138,000 positions, well below the average monthly gain of 181,000 during the prior 12-month period) and reduced pressure from inflation.

As measured by the Personal Consumption Expenditures price index, the Fed’s preferred gauge, inflation rose 0.2 percent in April, and so-called “core” inflation, which leaves out the volatile food and energy categories, climbed by the same percentage.

But, as MarketWatch reported, the rate of inflation during the 12-month period that ended in April slowed to 1.7 percent from a multiyear high of 2.1 percent in February. Core inflation dropped to a pace of 1.5 percent from 1.6 percent in March and 1.8 percent in February.

The Fed’s inflation target is 2 percent on the PCE index. Even as inflation remains below that level, a group of economists urged the central bank on Friday to raise its target. The group calls itself “Fed Up,” and it argues that moving the target higher would enable the economy to keep growing, averting a recession that could be caused by a series of ill-timed rate increases once the PCE index edges above 2 percent.

"The last decade should have shown us that the political system severely controls the tools that policy-makers have to fight recessions," Josh Bivens, director of research at the Economic Policy Institute, said in a conference call in remarks quoted in a CNBC report. "I see the higher inflation target as one of these buffers."

"The conversation about monetary policy rules that we follow going forward is a really important one, and it would have been important even if we hadn't gone through the Great Recession," Jason Furman, chairman of the Council of Economic Advisers under former President Barack Obama and currently senior fellow at the Peterson Institute for International Economics, told CNBC. "Having that [2 percent inflation] target today just leaves you less room than it used to."

Believing that the Fed will lift rates this week, Mohamed A. El-Erian, chief economic adviser at Allianz SE, explained why he thinks the central bank is no longer strongly reluctant to tighten its monetary policy in a column he prepared for Bloomberg View.

After the global financial crisis of 2008, the Fed embarked on a period of “unusually dovish monetary policy” that saw the central bank pass up chances to raise rates, El-Erian said. With Congress politically polarized, the Fed became the only government actor capable of doing anything to stimulate growth.

“And with the valuation of risk assets decoupled from fundamentals, the Fed worried about the risk that a premature tightening could destabilize financial markets, thereby undermining household and corporate confidence and creating yet another headwind to growth,” El Erian said.

“With time, however, Fed officials recognized that such an approach was not without its own risks — economic, financial, institutional and political,” he added. “As such, officials became more convinced of the need to advance a gradual normalization of monetary policy.”

El Erian said Fed officials have been guiding the public to expect a rate increase this week, just as they did before the Federal Open Market Committee meeting in March that produced a quarter-point increase.

“To advance this evolving policy shift, the Fed needs to accompany its rate hike [this] week with a reaffirmation of the likelihood of a third hike this year and provide the initial broad outlines of how it will start shrinking its balance sheet in 2018,” El Erian said. “And that is what it will most likely do.”

On Wednesday, as the Fed wraps up its meeting, economy watchers will get a look at the Labor Department’s Consumer Price Index for May and the Commerce Department’s report on retail sales, also for May.

The consensus view is that the price index rose 0.2 percent and that core inflation rose more slowly, at 0.1 percent. Retail sales are expected to have risen 0.4 percent overall and 0.3 percent with auto sales excluded.

On Thursday the Federal Reserve Bank of New York will release the Empire State Manufacturing Index for June and the Federal Reserve Bank of Philadelphia will release the Philadelphia Fed Manufacturing Index for the same month.

The consensus view is that the Empire State index will remain at -1 and that the Philadelphia Fed index will rise slightly to 38.8.

The Empire State index fell below zero in May for the first time since Donald Trump was elected president last November. By contrast, the Philadelphia Fed index surged to 38.0 in May from 22 in April and the predicted reading would show that manufacturing in the Mid-Atlantic region remains healthy.

Any reading above zero in the New York and Philadelphia indexes indicates improving conditions for manufacturing.

The National Association of Home Builders/Wells Fargo Housing Market Index also will be released Thursday. The June reading is expected to be 70, which would keep pace with the May level, and that figure was the second-highest since the Great Recession ended.

On Friday the University of Michigan will release its preliminary Consumer Sentiment Index for June. The expected reading is 97.1, which would be on par with the final reading for May. The December-to-May average for the index is 97.3, an elevated figure that coincided with Trump’s election as president.

If the index remains in that range it would show that consumers remain confident that the new president will be able to take steps to improve the economy, despite stumbles related to the Russia investigation and continuing divisions in Congress.


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