Parsing the FOMC minutes – The Daily Tearsheet

Vital Statistics:

Stocks are lower this morning after the hawkish FOMC minutes. Bonds and MBS are down.

The FOMC released the minutes from the July meeting yesterday. Basically they are very worried about inflation and sanguine about the labor market. On the labor market:

In their discussion of the labor market, participants observed that the unemployment rate remained low and that employment was at or near estimates of maximum employment. Several participants noted that the low and stable unemployment rate reflected a combination of low hiring and low layoffs. Some participants observed that their contacts and business survey respondents had reported being reluctant to hire or fire amid elevated uncertainty. Regarding the outlook for the labor market, some participants mentioned indicators that could suggest a softening in labor demand…. Furthermore, a number of participants noted that softness in aggregate demand and economic activity may translate into weaker labor market conditions, as could a potential inability of some importers to withstand higher tariffs. Some participants remarked, however, that slower output or employment growth was not necessarily indicative of emerging economic slack because a decline in immigration was lowering both actual and potential output growth as well as reducing both actual payroll growth and the number of new jobs needed to keep the unemployment rate stable. A few participants relayed reports received from contacts that immigration policies were affecting labor supply in some sectors, including construction and agriculture.

This was before the July jobs report which showed a huge downward revision in payrolls. I am not sure how much that would affect their decision-making however the labor market is a lot weaker than a 4.2% unemployment rate suggests. Note we will get one more employment report and we will get the 12 month revision of payrolls September 9. If we get another 800k downward revision like we did last year, it will be hard for the Fed to argue with a straight face that the labor market is strong.

On inflation:

With regard to the outlook for inflation, participants generally expected inflation to increase in the near term. Participants judged that considerable uncertainty remained about the timing, magnitude, and persistence of the effects of this year’s increase in tariffs. In terms of timing, many participants noted that it could take some time for the full effects of higher tariffs to be felt in consumer goods and services prices. Participants cited several contributors to this likely lag. These included the stockpiling of inventories in anticipation of higher tariffs; slow pass-through of input cost increases into final goods and services prices; gradual updating of contract prices; maintenance of firm–customer relationships; issues related to tariff collection; and still-ongoing trade negotiations. As for the magnitude of tariff effects on prices, a few participants observed that evidence so far suggested that foreign exporters were paying at most a modest part of the increased tariffs, implying that domestic businesses and consumers were predominantly bearing the tariff costs. Several participants, drawing on information provided by business contacts or business surveys, expected that many companies would increasingly have to pass through tariff costs to end customers over time. However, a few participants reported that business contacts and survey respondents described a mix of strategies as being undertaken to avoid fully passing on tariff costs to customers. A few participants stressed that current demand conditions were limiting firms’ ability to pass tariff costs into prices. Regarding inflation persistence, a few participants emphasized that they expected higher tariffs to lead only to a one-time increase in the price level that would be realized over a reasonably contained period. A few participants remarked that tariff-related factors, including supply chain disruptions, could lead to stubbornly elevated inflation and that it may be difficult to disentangle tariff-related price increases from changes in underlying trend inflation.

Surprisingly, they don’t even mention shelter inflation, which was the main culprit for the 2022-2023 inflation and is about to hit the inflection point where it goes from being inflationary to being disinflationary. Home price growth is stalling and asking rents have been declining for the past two years.

On the overall economy:

Participants generally pointed to risks to both sides of the Committee’s dual mandate, emphasizing upside risk to inflation and downside risk to employment. A majority of participants judged the upside risk to inflation as the greater of these two risks, while several participants viewed the two risks as roughly balanced, and a couple of participants considered downside risk to employment the more salient risk.

In previous statements, the Fed had characterized the risks to inflation and unemployment as “roughly balanced.” This seems to be a change.

Bottom line: They really don’t want to cut rates and will use any excuse they can to avoid doing it. IMO we are more likely to see a recession this year than a resurgence of inflation.

The bond market sold off a touch on the minutes, but was also bolstered by a decent 20 year auction. The Fed Funds futures now see a 80% chance of a September cut, compared to a sure thing a week ago. We will see what Powell has to say on Friday.

Donald Trump called on Fed Governor Lisa Cook to resign after FHFA accused her of occupancy fraud – i.e. claiming two properties (one in MI, on in GA) as primary residences in filings two weeks apart. That is a no-no. With Kugler’s resignation, Trump may get to nominate 2 governors.

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