How will the Fed react to recent economic data?
(MoneyWatch) COMMENTARY Recent news of modest increases in industrial production, capacity utilization and retail sales has led to speculation that this lowers the chance the Federal Reserve will do more to stimulate the economy at its next meeting in mid-September.
But other news such as the NY Fed Survey of Manufacturers and increases in inventories indicate a weakening economy. Overall, given the noisy nature of these monthly measures of performance, the Fed is unlikely to place too much weight on recent news. However, at the margin, recent data does make the Fed less likely to act.
What will matter the most to the Fed are two things: Inflation and unemployment. Recent price data shows relatively stable inflation, so the Fed has no more reason to fear inflation than it had at its last meeting. Inflation is running at or a bit below the Fed's 2 percent target depending on the measure that is used and if anything, inflation appears to be falling. Thus, while this leans slightly toward easing, there is nothing in the price data to push the Fed strongly in one direction or the other.
So the critical piece of information will be the jobs report for August. The report will come out a week or so before the next Fed meeting in mid-September to determine monetary policy. If that report shows reasonable job gains, then the chances of the Fed doing more are fairly slim. But if the report shows stagnation or hints at backsliding on jobs, then the chances are much better that the Fed will do more to stimulate the economy. But it will require a relatively large negative shock.
My colleague Tim Duy has an extensive review of recent data, and I agree with his bottom line:
The sum total of the data suggests that the Fed's much hoped-for acceleration in growth remains just hope, but that the worst downside fears have yet to be realized. Inflation continues to remain contained at rates below the Fed's mandate, but will not decline precariously (nor would I expect them to given downward nominal wage rigidities). There are some warning signs in the data flow, such as manufacturing surveys and inventories, but nothing conclusive. I want to argue that the failure of the economy to accelerate and below-target inflation, combined with more negative than positive warning signals, argue for additional Fed easing in September. That, however, has been the case for months, and during that period Bernanke has not moved the Fed to that easing (I tend to see the continuation of Operation Twist as holding the status quo, not additional easing). And I suspect signs that some of the weakness in the data was temporary will push Bernanke further away from additional easing, especially given his cost/benefit analysis. On net, I think the outcome of the September FOMC meeting remains a toss-up.
I think the default option for the Fed is to keep current policy on hold, and it will take a large dose of bad news about employment to move the Fed from this postion.
