28.07 Weekly Viewpoint : In the United States, consensus within the Fed was widespread on putting the rate hike cycle on hold

In the United States, consensus within the Fed was widespread on putting the rate hike cycle on hold and starting to normalise the balance sheet at the September meeting (barring external shocks); in the meantime, in Washington uncertainty reigns supreme over the reforms……

The FOMC meeting ended in line with expectations: monetary policy was left unchanged, but the Committee openly signalled that the start of the reinvestment tapering process is nearing. With the exception of the section on balance sheet policy, the statement was very similar to the one released in June. The assessment of the macroeconomic picture remained positive, and the Committee also noted the ongoing improvement of the labour market, economic growth at a moderate pace, and consumption and investment growth.

For what concerns inflation, it is on the decline and remains below the 2% goal, and the FOMC reasserted its commitment to closely monitor future price developments. Risks are still considered to be “roughly balanced”, and expectations are for a further strengthening of the labour market, and for inflation to rise back towards 2% in the medium period. For what concerns monetary policy, the interest rate scenario has not changed. The Committee continues to expect “that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate”, albeit still below the long-term level. The most important development in the statement concerned the balance sheet policy; however, this came as no surprise, as it had been well-prepared at considerable notice. The statement assures that for now repurchases will continue as in the past, although “the Committee expects to begin implementing its balance sheet normalisation program relatively soon, provided that the economy evolves broadly as anticipated”. This is a rather clear indication that, despite the relatively weak trend of current inflation, the FOMC has not changed plans and intends to start reducing repurchases in September, barring external shocks.

The minutes of the meeting will shed more light on the distribution of opinions within the Committee, although the unanimous vote signals widespread consensus per a break in the rate hike cycle and a start of the balance sheet normalisation process. The outcome of the July meeting also confirms that the FOMC is effectively staying true to its commitment to be as transparent as possible, to avoid unexpected volatility. Barring clashes in Congress preventing the debt ceiling from being raised ahead of the next FOMC meeting, we expect the gradual and automatic normalisation of the Fed’s balance sheet to be announced in September. The markets reacted positively to Yellen’s message, and given the prospect of stable rates in December, with the stock market back on the rise after some profit-taking session, the dollar returned to its lowest levels in 14 months and bond yields dropped by a few basis points. The weakness of the dollar may also be due to the hardships of the Trump administration. 

The Senate has rejected a bill to repeal Obamacare, with 55 votes against. Seven Republican senators opposed the bill which would have abolished current legislation, allowing two years to put in place a replacement scheme. The Senate will continue to discuss and vote amendments to current legislation, in the hope of finding a “lowest common denominator” on which to reach an agreement to repeal Obamacare. The Republican House leadership has expressed its hope to pass a “basic” bill to use as a platform for discussion to draw up a shared text to bring before the House. Uncertainty over the future of the health reform reigns supreme. The health care reform is perceived by the markets as a preparatory step to kick off the debate on the fiscal reform, which will be postponed to the autumn, at least.

In the euro area, growth will stay upbeat in the summer months as well.

In Europe, news flows on the cycle are still positive in Germany, with the IFO index setting alltime highs. In Italy, business confidence has improved across sectors with the exception of services. The composite PMI decreased in July, but remains at levels compatible with abovepotential GDP growth in the summer months as well. This week, the flash estimate should point to GDP growth of 0.65% q/q in 2Q, slightly stronger than in Q1.


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