- Amid economic data interpreted as more evidence growth is slowing, folks watched the Federal Reserve's rate decision closely.
- The Fed will maintain its exceptionally accommodative monetary stance but change the composition of its balance sheet.
- With inflation nowhere in sight, it seems reasonable to maintain significant monetary backing as the recovery takes up excess slack.
- Though a number of economic statistics are slowing, it should be noted the economy isn't sliding backward, just easing off an initial surge.
Slowing Chinese imports and falling US productivity brought out the bears Tuesday. Fresh off the morning round of data releases, eyes turned to the Federal Reserve's rate decision. The Fed's statement was cooler on growth prospects than recent iterations. So which is it? To grow or not? To satisfy ursine appetites with a double dip or "savor" just the one awhile longer?
The Fed doesn't seem overly worried about an impending recession—they're not loosening monetary policy further. Instead, the central bank announced it would maintain its $2 trillion balance sheet but change the composition. Currently, the Fed owns over $1 trillion in "toxic" mortgage-backed securities purchased at the height of the panic. Those assets are now gradually maturing (perhaps they weren't so poisonous after all?) and the Fed has to decide what to do with the proceeds.
There were worries a too-optimistic Fed wouldn't reinvest the funds and allow its balance sheet to slowly shrink—a moderately contractionary move. But allaying fears, the Federal Open Market Committee (FOMC) announced proceeds from maturing mortgage-backed securities would be used to purchase longer-term Treasuries. Put another way, the Fed's overall monetary stance (still exceptionally accommodative) won't change, but its balance sheet will slowly revert to a somewhat more conservative composition. With inflation nowhere in sight, it seems reasonable to maintain significant monetary backing as the recovery takes up excess slack.
Though a number of economic statistics are slowing, it should be noted the economy isn't sliding backward, just easing off an initial surge—which is quite normal at this stage in a recovery. Context is key! Chinese imports slowed a bit in July but were still hugely higher over last year—up 22.7% y/y compared to an even bigger 34.1% y/y increase in June. Some of China's stimulus tightening may be taking effect, slowing demand, but if so, only a little so far. And Chinese exports were up huge on healthy demand from around the globe, including the only recently forgotten problem child, Europe.
Q2 US productivity fell more than expected—but only after the strongest four-quarter run since 1961. Q1 productivity growth was revised up sharply from 2.8% y/y to 3.9%. Most of the Q2 weakness was in the slower services sector, even as manufacturers grew 4.5% more productive. One plausible explanation headline productivity fell is firms have pushed workers as far as they can and will need to hire more. That may bode well for employment.
The Fed seems to think the recovery is moving ahead and can largely handle a few bumps along the way, and we agree.