FOMC to Hold Rates Low Through 2022 as Deflation Fears Linger

Economic Report Monitor #40

June 10th, 2020

It's the last day of the June FOMC meeting as the monetary leaders continue to fight against COVID-19's economic effects. Their opening statement admits that the disease has brought "tremendous human and economic hardship" despite the improvements from the initial calamitous impacts. The FOMC reaffirmed their commitment to keeping rates low until "the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals." Based on the economic projections, this commitment means rates stay near 0% all the way through 2022 as the Fed projects a -6.5% GDP contraction and 9.3% unemployment in 2020. Both doves and hawks spoke in unison on this decision with only two FOMC members seeing a Fed Funds rate above the 0.0-0.25% range in 2022.

In support of that dovish statement of the Fed, the May CPI report came out with deflationary data. For the month, overall CPI fell -0.1% with the largest decline, again, from energy down -1.8%. Food CPI grew by 0.7% as meats saw a 3.7% surge caused by high demand and supply chain issues. An index tracking meats, poultry, fish, and eggs rose to a 10.0% YoY increase, the largest since March 2004. The beef CPI alone rose 10.8% in May. Just as high demand products see a surge, low demand products see a steep drop. Apparel CPI and transportation services CPI fell -2.3% and -3.6% respectively as the lockdown continues to impact these nonessential industries. The index that the Fed follows most closely, the CPI less food and energy, continued to drop farther from the central bank's 2% target at 1.2% YoY, down -0.3%. With those numbers, it's no surprise the Fed has remained dovish especially since it has been more than willing to maintain a policy of easing at inflation rates just barely off their target in times of expansion.

Despite the deflationary May CPI report, businesses responding in the Atlanta Business Inflation Expectations survey suggested that the June edition might bring some positive surprises. Up from a May estimate of  1.5%, businesses estimated that June inflation could improve to 1.7%, a number that is similar to the bottom range of surveys taken in 2015-2017. The main difference comes in the sales number which cratered from -3.0 in February to -66.0 in April and recovering slightly to -50.0 in June. Full recovery of consumption, and therefore sales, is likely to take some time until social distancing measures are completely lifted. Unit cost estimates were flat at 1.2%. This can probably be traced back to a drop in employment and hours worked which has lead to shrinking wages to cope with uncertainty in cash flow. In the end, if CPI does follow the path firms suggest in this report, it could be a misleading indicator to use to guide policy changes. Some other data points, specifically sales level, will probably deviate and obfuscate the true state of the recovery.

In another report touching on interest rates, the MBA Mortgage Applications report tracked its Composite index 9.3% higher on a 5.0% increase in the Purchasing index and an 11.0% increase in the Refinancing index. The light reopening of the economy combined with a drop in mortgage rates is sure to convince some individuals to have the confidence to take advantage of cheaper lending prices. Overall, the real estate market has remained relatively unscathed from the financial stress of COVID-19.

Finally, new data on the US oil and gas situation was released as energy futures recover from the bottom of their price fluctuations. Crude oil stockpiles grew 7.9 million barrels with 2.2 million going to the SPR and 5.7 million to commercial reserves. The Trump administration continues to stand by its commitment to absorb some oil supply, but production is still exacerbating the supply issue. That supple issue is unlikely to improve unless domestic production sees steeper drops. Last week, only 100k b/d of production went offline leaving 11.1 million b/d intact. Net imports also contributed to the surge in stockpiles as they grew 1.04 million b/d. In a more optimistic tone, products supplied saw a major improvement, growing 2.51 million b/d to 17.57 million b/d. This proxy for consumption is still -3.55 million b/d below where it was a year ago, but it gives some hope that demand issues could be easing. However, the 2020 summer months are unlikely to see the same consumption jump as previous months with a lighter driving season ahead.