Given an uneven economy, the Fed will likely stay put

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Amid a parabolic push by big tech stocks this week — briefly lifting the Nasdaq above 6,100 on Monday for the first time — Wall Street is bracing for the start of another two-day Federal Reserve policy meeting on Tuesday. 

While no rate hike is expected as policymakers gauge the effect of their quarter-point rate hike in March, the third increase of this tightening cycle that started in December 2015, all eyes will be on how officials interpret recent unevenness in the economic data.

Consider that first-quarter GDP growth slowed to just 0.7 percent amid the worst consumer spending performance since 2009 during a time of ebullient post-election confidence (as measured by a multitude of surveys) and record stock prices. Consumers, investors and businesses say they’re geared up and ready to spend, invest and hire.

But the on-the-ground reality says something different. And that presents a policy conundrum for the Fed.

At its last policy meeting in March, the Fed updated its economic projections (forecasting 2 to 2.2 percent GDP growth for 2017) and dramatically quickened the pace of policy tightening: From just two quarter-point hikes in two years, it unleashed its next increase after just three months in response to the post-election surge of confidence and resulting financial market gains.

Moreover, in recent months Fed officials have increasingly discussed the need to reduce the size of the central bank’s asset holdings after multiple iterations of bond-buying stimulus since the financial crisis. From around $800 billion before the crisis, the Fed’s balance sheet now totals more than $4 trillion.

In retrospect, this may have been too much too fast. Key leading indicators like loan growth have rolled over dramatically — with the decline in commercial and industrial lending happening at a pace associated with the last three recessions. CoreLogic recently noted that loan performance — a key indicator of typical economic expansions and recessions — is beginning to deteriorate.

Confirming all of this were first-quarter earnings reports out of the financial sector over the past month. Quarter-over-quarter lending at the largest U.S. regional banks declined in the period for the first time since 2013’s first quarter. Commercial loan balances didn’t change at JPMorgan (JPM) and Wells Fargo (WFC) compared to the fourth quarter of 2016, with Wells Fargo getting dinged for lower mortgage activity as well.

And early reads on the second quarter don’t look much better: A weaker-than-expected ISM manufacturing index for April suggests the weakness may be continuing. The reading for new orders fell to 57.5 from 64.5, while employment dropped to 52 from 58.9. While any measure over 50 indicates month-to-month growth, this is a rather dramatic slowdown suggesting the post-election confidence boost is fading.

Consumers continue to hunker down as well: The savings rate increased to the highest level since last August in April.

No wonder then that according to the CME’s FedWatch tool, which measures rate hike expectations based on futures trading, the market sees only a 4.8 percent chance of a rate hike this week. 

But the current economic unevenness is expected to fade: For the Fed’s June meeting, the market assigns 70 percent odds of at least a quarter-point hike. By the end of the year, short-term interest rates are forecast to be somewhere around 1.5 percent, up from 0.9 percent now. Hope springs eternal, it seems. 

While the Fed’s policy statement will likely be light on detail when it’s released Wednesday afternoon, watch for additional insight from Fed officials, including Vice-Chair Stanley Fischer and Chicago Fed President Charles Evans. Both will speak at an event on Friday at Stanford University. Chair Janet Yellen is scheduled to speak at a conference on Friday as well, but according to Keefe, Bruyette & Woods analysts, she isn’t expected to comment on policy. 

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Source: CBS News – Moneywatch

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