Color The Dot Plot

By Philip Marey, Senior US Strategist at Rabobank

Color the Dot Plot

EUR/USD dropped below 1.070 this morning and GBP/USD below 1.265 as the Fed still looks relatively hawkish compared to central banks across the Atlantic. The Bank of England’s MPC maintained the policy rate at 5.25%, a decision that was ‘finely balanced’ for some members. The vote concluded with a 7-2 split, in line with expectations. The central bank appears to be preparing the markets for a first rate cut in August, which continues to be our base case. We have, however, removed a subsequent September cut from our forecasts. This follows yesterday’s services inflation data. Services inflation remains a concern, and whether it is diminishing or persistent is largely a matter of judgment, with notable differences of opinion within the MPC. Governor Bailey didn’t provide additional color to this meeting outcome and the pre-election purdah means we will hear nothing from members until after July 4. Meanwhile, it is likely the Conservatives will pay the price for the surge in inflation and the incoming Labour government is going to take credit for the upcoming rate cuts. For more details, we refer to Stefan Koopman’s BoE Post-Meeting Comment.

US initial jobless claims fell back a little, to 238K in the second week of June from 243K in the first week. However, the initial jobless claims remain well above the 224K average of May. In fact, they have shown an upward trend since falling to 194K in the second week of January. This means that the labor market is gradually cooling off. This should be good news for the Fed.

However, at the same time US housing starts fell by 5.5% in May and building permits by 3.8%. This means that not enough homes are built to reduce the price pressures in the housing market. Consequently, it will take longer for housing inflation to come down. This shows that rates policy sometimes works in the wrong direction, as high interest rates are now holding back the supply side of the tight housing market. This is definitely bad news for the Fed, especially because they still need high rates to continue to cool off the labor market.

For the Fed, the last mile of inflation remains difficult to overcome and this led to last week’s downward shift of the dot plot, with the median number of rate cuts for this year falling to one from three. A couple of Fed speakers added some color to the dot plot yesterday.

In a fireside chat at the Michigan Bankers Association, Neel Kashkari (Minneapolis Fed, non-voting FOMC participant) said that the strength of the economy has been a pleasant surprise and that the fundamentals of the economy are sound. However, he admitted that the US economy is showing signs of softening, but at the moment, it is “very, very hard to know” how the economy will evolve. About the path of interest rates, Kashkari said: “Do you know what we’re all basically saying? It depends what happens with the economy. If inflation is persistent, interest rates will be higher for longer, while if inflation falls, that means the Fed can normalize interest rates more quickly.” Kashkari said it would probably take “a year or two” to get inflation back to the Fed’s 2% target. That prediction is not far off the median Fed forecast. Earlier this week, Kashkari said it was reasonable to expect the that Fed won’t cut interest rates until December.

Thomas Barkin (Richmond Fed, votes in the FOMC this year) needs further clarity on the path of inflation before lowering interest rates. He said: “My personal view is let’s get more conviction before moving” and he repeated that he needs sustained and broadening progress toward the Fed’s 2% goal before cutting. Responding to a question that could have been asked to an ECB governor, i.e. if the Fed could do one rate cut and hold at that level, Barkin said it depends on the economy. If current conditions hold, he said it may not be the best time to give guidance on timing about subsequent policy adjustments. “There are times where we will want to give forward guidance and have given forward guidance,” he told reporters. “This doesn’t feel like one of those times to me. It doesn’t feel like a forward guidance time. At this moment it feels like if you made a cut, you made a cut, and then let’s see where the data takes you.” In other words, as far as Barkin is concerned, the Fed is really data-dependent.

Mary Daly (San Francisco, voting FOMC participant this year) did not talk about monetary policy, but seems to be an expert on artificial intelligence and reassured us that no advanced technology has yet caused net unemployment. So we don’t have to worry about that.

Former St. Louis Fed president James Bullard, who was often ahead of the FOMC pack, said that the latest inflation print has brought a September rate cut back into play. Bullard recently changed his view to two rate cuts from the three he had envisioned in April as inflation moved toward the central bank’s target and the economy remained resilient. He ruled out the chance of a hike later this year. “If they want hawkish policy, they can keep rates at where they are. They can delay easing,” he said.

Meanwhile, ECB’s Klaas Knot said there’s a “strong case” for the European Central Bank to decide on interest rates once a quarter when new economic projections are available. Officials have “little experience” with easing monetary policy gradually and are faced with still-high uncertainty and structural shifts in the global economy that warrant a “data-dependent approach.” That means the ECB will have to “wait for incoming data, including new projections, and then decide accordingly,” he said. “Given the current environment we still have to avoid any commitments on a specific future rate path. There is a strong case for using projection meetings to recalibrate our policy stance, as these meetings allow us to update our assessment based on a richer set of information,” he said. “This is particularly the case at the current juncture, given still lingering risks of higher wage growth.” With the next set of forecasts available in September, Knot’s comments suggest he’s in favor of taking a break in July before considering another cut.