Economic Commentaries

10

In recent Commentaries we pointed to trending weakness in economic data reports as denting global growth prospects and turning attention back toward a U.S. centric one. A strengthening dollar exchange rate, on again off again trade issues, and weak European data reports were all in play over the past few weeks.

Meanwhile, domestic economic indicators point toward a resumption of economic momentum. ISM activity reports for May recouped lost ground from recent months while remaining below levels of late last year. The important orders/inventory mix widened to double digits for the first time this year. And the labor market posted a solid gain for May across almost all industry groups.

For us the implication is that QII GDP is on track for roughly 3.5% growth in the spring quarter with little inflation pressure. Commodity prices have come off the boil. Slow growth in aggregate hours suggests a solid productivity performance while wage growth continues in a 2.5% to 3% range. And importantly since it is key to forming inflation expectations, oil prices have eased since the administration's announced abandonment of the Iran nuclear agreement.

Mideast tensions are an ever present wild card and the probability of a geopolitically induced price spike is not infinitesimal. But with U.S. production continuing to increase and the Saudi - Russia alliance hinting at a production increase to offset any supply disruption, the threat may be contained. What if oil prices stabilize? There would be a moderation in the published price indexes; inflation expectations would ease; and discretionary purchasing power would improve without a negative offset in activity in the oil patch.

The FOMC will most likely raise its benchmark federal funds target at this week's meeting while maintaining its balance sheet reduction schedule. But the meeting is followed by an update of its forward guidance and a press conference with the Chairman. This is what roiled markets a few months ago. Maintaining aggressive guidance would further tighten financial conditions as the interest rate yield curve would continue flattening while the dollar exchange rate would remain firm. Financial markets and emerging markets cold feel the heat as a result.

In our view this is unwarranted and on any slip in the economy following such action would very likely invite an unwelcome tweet from the White House. Why feed the beast when the underlying fundamentals might best be described as an economic soft landing? The externalities of trade spats and political chaos are potential dents in a soft landing, but the FOMC cannot control these. It can and should signal that the fundamentals of low inflation and stable economic growth imply that a neutral federal funds rate is closer at hand that its past guidance had suggested.

Posted in: General