KEY DATA: GDP: +3.9% (from 3.7%)/ Confidence: down 4.7 points
IN A NUTSHELL: “With the economy in good shape, Chair Yellen’s strong hints that hike this year is likely have to be heeded.”
WHAT IT MEANS: Second quarter GDP was revised up again. Consumers spent even more than thought and business construction was actually decent. On the other hand, the inventory build was a little less. There was also an upward revision to profits, which grew a little faster than initial estimated. Overall, this report reminds us that the U.S. Economy is in good shape.
Consumer confidence faded in September as the University of Michigan’s Consumer sentiment index fell fairly solidly. However, this was likely due to the wild volatility in the equity markets early in the month. Indeed, confidence rose from the mid-month reading.
Chair Yellen’s Comments and Fed Policy: Last night, Fed Chair Yellen gave a speech that should be reviewed closely. Yes, she reiterated a lot of what had been said, but there were some clear messages that she was sending. First, She once again stated that she and most other Fed members expect to raise rates this year. As today’s data show, the economy can absorb a rate hike. As for the Chinese wrench that was thrown into the rate hike gears, she noted that “we do not currently anticipate that the effects of these recent developments on the U.S. economy will prove to be large enough to have a significant effect on the path for policy.” In other words, never mind. On the inflation front, she is sticking to her view that “inflation will return to 2 percent over the next few years as the temporary factors that are currently weighing on inflation wane”. We now know that the “medium term”, the phrase used in the FOMC statements, refers to a “few years”. As for those who argue we should wait until all the uncertainties have dissipated, she noted that “monetary policy affects real activity and inflation with a substantial lag. If the FOMC were to delay the start of the policy normalization process for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession.” Finally, she quashed the “one and done” rate hike theory when she noted that after the first increase, there would be a “gradual pace of tightening thereafter.” The Fed is not going to simply stop, look and listen. Once started, the members expect to move in a restrained, but consistent pattern.
With only two meetings left before the end of the year, October 27-28 and December 15-16, it seems that it will take disappointing data to prevent a rate hike. If by December, the unemployment rate is at or below 5% (not a heroic assumption since it is currently 5.1%), job gains are strong enough to point to further unemployment rate declines and there are indications that wage inflation is accelerating even modestly, the FOMC should finally pull the trigger. With only one employment report and no Employment Cost Index number before the October meeting, it looks like December 16 could be H-Day, the day the long-awaited hike occurs.