Essential Economics

— Mark Frears

A lot of pressure

What are you known as? Introvert, extrovert, passive, combative, book-smart, street-smart or a combination of many?! There are lots of tests out there to evaluate; used to be Myers Briggs and DISC, and now the Enneagram is very popular. Don’t ask me my number (never took it) but I sure heard my kids talking about it. I think you know what type of person you are, but it does have some benefits in seeing what other people are, and how to understand them better.    

It would be interesting to be a fly on the wall to see the interactions of people in the Federal Open Market Committee (FOMC) this week. What exactly are they talking about?

Fed Funds

The primary tool that the FOMC uses is the overnight fed funds rate. This is the rate at which banks trade money between themselves and is considered the benchmark for riskless overnight trading. As you can see below the Fed Funds futures are predicting the Implied Rate to be 4.647% by the December 18 FOMC meeting. The current rate is 5.33%, so they expect 2.727 25 basis point (bp) rate cuts by then. Keep that in mind as we discuss the makeup of this independent body.

Source: Bloomberg

Who is the FOMC

This group, from the U.S. Federal Reserve System, is a very important part of the economic landscape. The makeup of the committee is as follows:
  Seven Board of Governors of the Federal Reserve System (including Chair Jerome Powell)
  President of the Federal Reserve Bank of New York
  Four Reserve Bank Presidents (four of the remaining 11 rotate on an annual basis)

Their dual responsibility is to: one, ensure full employment (keep rates low to stimulate economic activity) and two, keep inflation under control (raise rates to levels that will make borrowing more difficult and therefore slow the economy).  

Their means of executing this responsibility is by setting open market operations. The primary method of influencing interest rates and the economy is the overnight Fed Funds Target. This is the rate that money is transacted among banks on an overnight basis. Secondarily, they also execute purchases of longer-term U.S. Treasury debt (UST), and mortgage-backed securities (MBS) to influence longer-term rates.  

As you can see, they have a huge amount of influence on the interest rate markets, and their actions are closely watched by all markets, including equities and foreign exchange.

Hawks and Doves

The members of the FOMC may or may not take personality tests, but the economic community has done that for them! Based on their bias toward reducing inflation (Hawks) or reducing unemployment (Doves), they have a known opinion. The chart below summarizes the current makeup of the committee.

Source: Bloomberg

As you can see, in 2024, the average member is over toward the Hawk side, with only five members at neutral or on the Dove side. Not all of these members have votes in 2024.

The Fedspeak index, shown below, indicates we have come back down close to neutral, but recently spiked back toward a hawkish mode. Recent speakers have been conveyed by the media as leaning more dovish, as the media really wants to sell the story of a near-term rate cut.

Source: Bloomberg

Bottom line

While one rate cut of 25bp would not have a material impact, this would show markets that the FOMC believes inflation has been vanquished and are willing to lower rates to stimulate the economy. This is really driving positive momentum in the equity market and could be overdone.

The current strength of the economy, demonstrated in a 2.8% Q2 GDP, is a reason to not cut rates. The economy does not appear to need stimulus. Perhaps the FOMC could be proactive in lowering rates, but they are usually late to the party.

Another complicating aspect is the upcoming Federal election. In the past, there has never been a change in direction in policy actions within 11 months of the election. If they were to cut rates before the election, that could be construed as benefiting the current administration as it would be stimulative to the economy. The FOMC likes to proclaim their political independence, so this could get dicey.

The meeting this week begins on the 30th, culminating in a press release and press conference with Chair Powell on the 31st. No rate cut or hike is expected at this meeting, but all eyes will be looking for clues as to timing of the first cut. Futures would tell you that will happen in September, but we still have two payroll releases and two CPI releases before that meeting. Much could change. Stay tuned.

Economic releases

Last week was Housing, GDP, Pesonal Income and Spending, as well as the PCE inflation metric. All came in a bit stronger than expected, without any big surprises.

This week’s calendar is employment and the FOMC. Period. Press conference on Wednesday at 1 p.m. CT will be more closely watched than the Olympics. See below for details.