On the August FOMC

The FOMC sees the economy as strong and strengthening, using versions of those words six times (up from five at the last meeting). The language claiming that policy is “accommodative” remains, but in fact the funds rate is only half-a-hike below the Fed’s estimate of R-Star. When Q-2 data flows into that estimate, the neutral rate will likely move higher, giving the Fed more runway for gradual rate hikes before one of them actually becomes a tightening. We think the economy will continue to justify hikes, with continuing improvement in growth, inflation and long-term yields. Absent that improvement, Trump’s controversial case for caution is right. For now, the yield curve remains near-flat, and the Fed’s asset portfolio is days away from shrinking to the level of the M1 money supply, at which both QE2 and QE3 were launched.