As expected, the FOMC tapered by another US$ 10B in July with few changes in the monetary statement. The reduction in purchase was evenly divided between Treasuries and MBS, taking the former down to US $15B per month and the latter down to US $10B per month. Policymakers acknowledged rebound in the economy in the second quarter of the year, noting ‘somewhat diminished’ downside risks to inflation and improvements in labor market conditions. Yet, they cautioned that a number of labor market indicators signaled that slacks remained ‘significant’. The statement suggested that the Fed is not in any rush to hike interest rates.
The Fed made some subtle changes on its assessment on the labor market and inflation. for the former, policymakers replaced the reference that the unemployment rate ‘remains elevated’ with ‘a range of labor market indicators suggests that there is significant underutilization of labor resources’. This echoed with chair Yellen’s opinion that the decline in the unemployment rate exaggerated the actual improvement in labor market conditions and other indicators which probably includes wages, long-term unemployment, part-time for economic reasons and the participation rate. The comments also indicated that the Fed has put more focused on slack which the officials believed remained elevated as evidenced in the lack of meaningful acceleration in wages.
On inflation, the members judged that ‘the likelihood of inflation running persistently below 2 percent has diminished somewhat’ and inflation has ‘moved somewhat closer’ to the Fed’s longer-run objective while longer-term inflation expectations have remained ‘stable’. Previously, Chair Yellen noted that recent pickup in inflation was due to ‘noise’. she also indicated that modest wage gains were ‘not rising to the point where they can give way to inflation. At this point, we find the July statement was somehow inconsistent in judging that downside risks to inflation have diminished, while emphasizing the slacks in a series of labor market indicators including wage.
The statement was released following the 2Q14 GDP data which surprised to the upside.
Real GDP expanded +4.0% in 2Q14 with consumption and inventory building together contributing +335 bps to growth. The biggest drag on growth was imports which shrank growth by -190 bps. The core PCE deflator grew +2% at annualized rate and pushed up the GDP deflator by a similar amount. Thus, nominal GDP grew +6.0% during the quarter. Revisions were made on the data over the past 3 years. Notably, 3Q13 real GDP growth was revised +40 bps higher to +4.5% while 4Q13 GDP growth was revised up +90 bps to +3.5%. The contraction in 1Q14 was revised to -2.1% from -2.9%.