July FOMC Meeting Preview: Fed's Statement is Expected to Echo Powell's Recent Dovish Remarks

The Federal Open Market Committee is scheduled to convene for their upcoming session on July 30-31. The committee is widely expected to keep the federal funds rate bound between 5.25% and 5.50%. After the end of their two-day meeting, the statement will be released at 14:00 ET, followed by a press conference with Chair Jerome Powell scheduled for 14:30 ET.

The upcoming meeting is expected to set the stage for a rate reduction in September, marking a transition from a restrictive policy stance towards a more neutral position.

The inflation measure favored by the Federal Reserve showed further modest easing. In June, the primary PCE deflator saw a minimal increase of only 0.1%. Across the board, the details were positive. Prices for goods saw a decrease for the second consecutive month, and there was no indication of rising prices in the services sector. The core PCE deflator, which is typically more stable, was slightly higher at 0.2%, yet this still represented the second smallest increase of the year.

The increase in nonfarm payrolls for June was a modest 206,000, slightly surpassing expectations, but significant downward revisions of 111,000 jobs for the previous two months brought the three-month average for job creation down to 177,000. This rate is not only well below the estimated 250,000 jobs needed monthly to match labor force growth and maintain 'breakeven', but it is also the weakest three-month job gain average since early 2021.

In the same time frame, the unemployment rate climbed to 4.1%, the highest since November 2021, although the uptick occurred alongside an increase in labor force participation. Yet, other indicators suggest emerging weaknesses, such as the number of ongoing jobless claims, which have reached their highest point in over two years.

As Chair Powell noted in his recent speech, the labor market is now “essentially no tighter” than it was prior to the pandemic.

The differential between the 2-year yield and the effective federal funds rate has reached a recent low of -93 basis points, setting the stage for the anticipated rate reduction cycle. Historically, when this spread reaches -100 basis points, it often signals that the market is ready for the initial rate cut and potentially the start of a series of reductions. Currently, the 2-year yield is around 4.4%, with expectations that it will move towards 4% in the next few months.

Similarly, the 10-year yield is progressing towards the 4% mark, now sitting in the vicinity of 4.2%. With less than a 20-basis point inversion in the yield curve, we are witnessing a flattening as both yields approach 4%. Should this trend continue, and as the Federal Reserve begins to implement rate cuts, it is expected that the yield curve will shift from flat to an upward slope over the months to follow.

The statement is likely to echo recent remarks from Chair Powell, in that the economy is beginning to make more substantial progress towards the inflation target, with the “modest” description from the June statement likely to be removed. It is likely that the July statement will also mention the increasing signs of fragility that are emerging in the labor market, noting that risks to the dual mandate of stable prices and full employment are now coming back into much better balance.

Observations regarding liquidity conditions and the reduction of the Federal Reserve's balance sheet are typically found within the more detailed sections of the statement and are seldom a focal point of discussion during the press conference unless specifically prompted by questions. It is anticipated that this approach will continue in the upcoming session.

Regarding Chair Powell, his remarks during the post-meeting press conference are expected to align closely with his recent communications, including those made during Congressional testimony and other public addresses. Powell is anticipated to reaffirm the view that the latest inflation data have bolstered confidence in the ongoing disinflationary trend, and emphasize that risks to the Fed's dual mandate are now bidirectional, suggesting that inflation is not the committee's only concern.

Furthermore, it is not very likely for Powell to make any firm commitments regarding future policy actions. He is also expected to handle any questions about the forthcoming presidential election with neutrality, avoiding speculation on how the election might influence monetary policy decisions.

Overall, the July FOMC meeting is expected to reaffirm and potentially reinforce the longstanding concept of the 'Fed put'. This is likely to uphold investor confidence to maintain positions in risky assets, and lead to a continued upward trajectory for equity markets, with any market pullbacks being viewed as buying opportunities.