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Investors Should Revise their Liftoff Expectations as FOMC Remains on Track to Raise Rates this Year

On Friday, San Francisco Fed President Williams (dove, FOMC voter) and Cleveland Fed President Mester (moderate, FOMC non-voter) both said they expect the FOMC to begin liftoff at some point later this year.

 

According to CNBC, San Francisco Federal Reserve President John Williams believes the U.S. central bank should raise rates twice this year if economic data meet expectations. In the meantime, according to WSJ, Federal Reserve Bank of Cleveland President Loretta Mester said raising rates right now wouldn’t be a problem for the economy as a whole.

 

These two statements confirm that most of FOMC members seem ready to raise rates this year. The fact is that the median dot plot for 2015 remained at 0.625% during the June FOMC meeting. It suggests that the committee expects at least two hike in 2015 despite that the World Bank joined the IMF in urging the Federal Reserve to hold off raising rates until 2016.

 

As suggested by the chart below, the gap between investors’ expectations and FOMC projections remains huge. But if data keeps on improving in coming weeks and Grexit is avoided, investors should revise upward their expectations concerning the pace with which the FOMC will tighten its policy.

 

 

 

Beige Book: Little Changed From Last Report

Yesterday, FOMC published Beige Book which shows that activity continued to expand at a modest to moderate pace during the reporting period of early July through late August.

 

A few excerpts from the Fed classified by theme:

 

1/ Sum up
- Activity continued to expand at a modest to moderate pace during the reporting period of early July through late August. Eight Districts characterized growth as moderate; of the remaining four, Boston, Atlanta, and San Francisco reported modest growth, and Chicago indicated activity had improved.
 
2/ Consumption
- Reports indicated that consumer spending rose in most Districts. A few Districts mentioned that back-to-school sales contributed to overall consumer spending growth.
 
3/ Manufacturing
- Manufacturing activity expanded modestly during the reporting period.
 
4/ Nonfinancial Services
- Demand for nonfinancial services improved modestly overall since the previous Beige Book. Adjusting for seasonal fluctuations, providers of various professional and business services such as accounting, consulting, information, transportation, and legal services generally expanded their activities.
 
5/ Real Estate and Construction
- Activity in residential real estate markets increased moderately. The pace of sales of existing single-family homes continued to increase moderately in most Districts.
- Reports from several Districts suggested that rising home prices and mortgage interest rates may have spurred a pickup in recent market activity, as many “fence sitters” were prompted to commit to purchases.
- Many Districts reported that limited inventories of desirable properties contributed to upward price pressures.
- Demand for nonresidential real estate increased. Office vacancy rates and other indicators in markets for office space improved modestly in the major metropolitan markets.
 
6/ Banking and Finance
- Lending activity weakened a bit, and several Districts reported less-favorable conditions than in the preceding reporting period.
- Lending standards were largely unchanged, while credit quality improved.
 
7/ Employment and wages
- For most industries and occupations, hiring held steady or increased somewhat in most Districts.
- Wage pressures remained modest overall.
 
8/ Inflation
- Upward price pressures were subdued, and price increases were limited during the reporting period.

 

My view
 
No surprise, the pace of growth remains historically weak as it keeps on expanding at a modest to moderate rate. Employment situation is slightly improving while inflation stays subdued. On the positive side, we can note that residential real estate market shows positive signs despite rising mortgage rates, however, on the negative side, financial conditions are weakening a bit with lower lending activity.

 

This analysis is broadly in line with Fed’s Williams comments yesterday which suggests that tapering should start later this year.  At the opposite, this morning, Fed’s Kocherlakota said the central bank’s outlook for inflation and unemployment calls for more accommodation.
 
 
***Remind that all Fed members’ speeches concerning QE and economic activity since the last FOMC meeting (July 30-31) are available here.