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Your Bank > News

CNB Economic Comments May 26

May 30, 2017

From: Gregory S. MacKay, Economist
Date: May 26, 2017

The recent meeting of the Federal Open Market Committee (FOMC) left interest rates unchanged, but left the marketplace with questions on the strength of the economy and future interest rate hikes. The minutes of that meeting have been released, and some answers are becoming apparent. With the next FOMC meeting scheduled for June 13-14, let’s take a look at current Fed speak:

On a rate hike: “Most participants judged that if economic information came in about in line with their expectations, it would soon be appropriate for the committee to take another step in removing some policy accommodation.”

On the economy: “In their discussion of monetary policy for the period ahead, members judged that information received since the Committee met in March indicated that the labor market had continued to strengthen even as growth in economic activity had slowed. Job gains had remained solid, on average, in recent months, and the unemployment rate had declined. Household spending had risen only modestly, but the fundamentals underpinning, the continued growth of consumption remained solid, while business fixed investment had firmed.”

On the economy: “Members generally judged that it would be prudent to await additional evidence indicating that the recent slowing in the pace of economic activity had been transitory before taking another step in removing accommodation.”

On inflation: “Inflation, measured as the 12 month change in the PCE price index, had been running close to the Committee’s 2 percent longer run objective. Core inflation continued to run somewhat below 2 percent. Market based measures of inflation compensation had remained low, while survey based measures of longer term inflation expectations had changed little on balance.”

On inflation: “Participants generally continued to expect that inflation would stabilize around the Committee’s 2 percent objective over the medium term… a few participants, however, expressed uncertainty about the reasons for the unexpected weakness in inflation measures and, about its implications for the inflation outlook.”

On inflation: “Members also agreed to continue to carefully monitor actual and expected inflation developments relative to the Committee’s symmetrical inflation goal, with one member viewing further progress of inflation toward the 2 percent objective as necessary before taking another step to remove policy accommodations.”

On fiscal activity: “A number of participants pointed out that clarification of prospective fiscal and other policy changes would remove one source of uncertainty for the economic outlook.”

Special mention: “Several participants pointed to conditions under which the Committee might need to consider a somewhat more rapid removal of monetary accommodation – for instance, if the unemployment rate fell appreciably further than currently projected, if wages increased more rapidly than expected, or if highly stimulative fiscal policy changes were to be enacted.”

On balance sheet matters: The Fed staff offered a proposal to allow a certain portion of maturing securities to run off, thus shrinking the Fed’s balance sheet. The runoffs would begin slowly, would be adjusted quarterly, would be well announced to the marketplace, and would continue until the balance sheet was normalized. Changes to the procedure would be determined by the economic outlook. Nearly all participants agreed that, with the economy and federal funds rate evolving as expected, the process could begin this year.

So what’s it all mean? A rate hike “soon”…. or “await additional information”? The Fed’s mandate makes consumer spending (retail sales, home sales, jobs, wages) and inflation (mainly the Personal Consumption Expenditure Index (PCE)) all important, with a new twist: the expectation of some kind of fiscal stimuli coming out of Washington.

A quick look at President Trump’s 2018 budget matches his campaign promises: More spending on defense, border security and infrastructure, less on entitlements and other social programs. Add in $3.6 Trillion in spending cuts over 10 years and pass it on for Congressional consideration.

As for consumer spending, the April new and existing home sales data were a little weak, but new home sales nationally for the past six months are 11.3% ahead of the similar period in 2015-2016. Existing home sales are actually being hurt by a lack of inventory, but are up 1.6% over April 2016 and prices are 6.1% above April 2016 prices.

The second estimate of first quarter GDP took some of the mystery out of the future. While first quarter GDP growth was revised up to 1.2% (weak, but better than the 0.7% first estimate), the PCE inflation index took center stage. For the first quarter of 2017, the PCE index was 2.4%, and the core was 2.1% - both at, or above 2% for the second consecutive quarter.

While durable goods orders for April fell from March and February strong gains, it seems most likely that the FOMC will nudge the federal funds rate up ¼% at its June meeting given the PCE and GDP recent releases.

Stock prices continue to hit or remain near new highs as most earnings reports have been positive.
At Friday’s opening, for the week and year:

Index 05/26/17 Weekly Change Year-to-Date Change
Dow Industrials 21083 +1.3% +6.7%
NASDAQ 6205 +2.0% +15.3%
S&P 500 2415 +1.4% +7.9%

Intermediate term Treasury bond yields fell about 0.10% in the past couple of weeks as more muted long term inflation predictions surfaced. Muni’s had a slightly large adjustment.

Return Period
U.S. Treasuries Municipal Bonds
05/26/17 05/12/17  05/26/17 05/12/17
2 year 1.29% 1.30% 0.91% 1.00%
5 year 1.77% 1.86% 1.29% 1.42%
10 year 2.23% 2.34% 1.96% 2.14%