Fed Factor | December 8, 2017

Markets have fully priced in the Federal Reserve Board’s (FRB) anticipated rate hike on Wednesday. So, why will all eyes be on the meeting?

Economic Data

Data showed continued expansion this past week, but with a tone of moderation. Factory orders experienced a slight fall, but this came in the wake of two months with over a full point of growth. ISM manufacturing and Non-Manufacturing data soften, but well in excess of 50; which marks the line between contraction and expansion. Consumer sentiment has been quietly eroding over the past three months. It should be noted though that the erosion of this indicator comes as it reached an all-time high of 101.1. For the purposes of the FRB, the most important statistic is the fact that unemployment remained unchanged at 4.1% and wage growth remained tame.

The unemployment rate is one of the two mandates given to the FRB. The first mandate is keeping us near full employment. A place we have been for the last couple of years. Wage growth is an indicator of the second mandate, inflation. Strong wage growth leads to more disposable income, which leads to more spending, giving corporations a capacity issue. When you cannot create any more goods, you raise prices to stymie demand… inflation.

On the one hand, near full employment warrants a rate hike to replenish the FRB’s tool box and is unlikely to cause damage to job creation. On the other hand, stagnant wage growth should not lead to inflation, as has been the case for the last several years. The likelihood of a rate hike is born out of employment, while inflation is contained. The markets have priced in a rate hike as a certainty.

So why the interest in this week’s meeting? The FRB will also lay out their intended path of rate hikes for 2018. This will give us a good idea of the FRB’s thoughts on US momentum going into the new year. It will also give us a good indication of how loose or tight monetary policy will be for 2018.

 

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