The Fed’s Difficult Decision at July’s FOMC Meeting

Chief Economist Eugenio J. Alemán discusses current economic conditions.

We understand that markets have already decided for the Federal Reserve (Fed) regarding what it is going to do with rates during the July 25-26 Federal Open Market Committee (FOMC) meeting. Markets are betting 93.6% to 6.4% (as of 11:00 AM ET on Friday, July 14, 2023) that the Fed is going to increase the federal funds rate by 25 basis points (bps). However, we are still not convinced, and we may have to recognize that we were wrong… but we still have some time to prepare.

If the Fed is true to its long-professed ‘data-dependent’ mantra, and we hope it is, then it is very difficult to justify another increase in the federal funds rate at this time. This is because the largest contributor to the 0.2% increase in June’s core Consumer Price Index (CPI) was shelter costs, up 0.4% during the month, and since we know that shelter costs are going to start slowing down fast during the second half of the year, then this means that inflation is also going to slow down considerably during the second half of the year.

Perhaps the biggest risk, once again, is the potential for further increases in energy costs due to the recent increase in the price of petroleum, and that could help convince some Fed officials of the need to go for another 25 bps to try to preempt any acceleration in inflation going forward. However, if Fed officials are certain that core prices will continue to disinflation, then they should stay put and wait for more information down the road.

Having said this, Fed officials need to realize that this disinflationary process is occurring at the same time that the U.S. economy seems to be growing faster than potential growth, the rate of unemployment remains very low, and the labor market remains tight, but has started to show some signs of coming into balance. This should be enough for an institutional body that professes that it conducts monetary policy in a ‘data-dependent’ way.