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Fed rate hike dithering signals still struggling economy

Janet Yellen
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Janet Yellen

It's no surprise that the Federal Reserve opted to keep rates unchanged at the July Federal Open Market Committee meeting; the Fed will maintain the current range of 0.25 percent to 0.50 percent.

Also as expected, the Fed improved its assessment of the labor market, noting that conditions have "strengthened." While recognizing that payroll growth was "weak" in May, the Fed specifically highlighted the strength in the June employment report that followed. On balance, however, the Fed noted that labor market indicators suggest just "some increase" in labor utilization – a positive but hardly robust endorsement of recent labor market activity.

According to the July FOMC statement, household spending is "strong," however, business investment is "soft." Without strength in business investment and development resulting in robust job and income creation, going forward, there is little hope of maintaining even a moderate pace of spending let alone gaining momentum in consumer activity from here.

Additionally, in the July statement, the Fed continued to acknowledge the still-sluggishly low level of inflation continuing to "run below the committee's 2 percent longer-run objective," and that market-based measures of inflation compensation remain "low." While some may argue the Fed's mandate of full-employment is nearly met, the other half of the equation, stable prices, remains unequivocally unachieved.

Overall, the Fed remains optimistic that given "gradual" adjustments of the federal funds rate, the economy will continue to expand and labor market indicators will strengthen. Furthermore, while inflation is currently below the Fed's longer-term target, price pressures are expected (as they have been for years!) to mount as the impact of "transitory" energy and import price effects dissipate.

On balance, the Fed noted that "near-term risks" to the Fed's outlook for the economy have "diminished." No doubt the recent improvement in the June non-farm payrolls report and the return of relative calm to global financial markets have helped ease concerns of Armageddon, emboldening the hawks on the Committee. Nevertheless, the lingering fragility of the domestic economy coupled with still-ample uncertainty has not eradicated said "risks," keeping policy makers cautiously optimistic.

On the international front, the July statement noted that international developments will continue to be monitored closely, however, no further alarm or concern was added to the language surrounding developments abroad.

The sole dissent was Esther L. George who preferred to raise the target range for the Federal funds rate to 0.50 percent to 0.75 percent.

Here's the bottom Line: Given the still-lingering, albeit diminished, potential downside risks to the Fed's internal forecast for further improvement in the labor market and inflation coupled with recent market-moving events abroad, the committee faces no sense of urgency to further adjust policy. In fact, like the Bank of England and European Central Bank, given the heightened level of uncertainty in today's marketplace, the Fed is likely to remain on the sideline for longer than expected, waiting for further information and data to suggest the U.S. economy has returned to a sustainable moderate pathway and that the risks of contagion from developments abroad have been extinguished.

While at first glance the July statement may appear to be a bit more rosy and potentially suggesting the Fed is ready to continue with raising rates near-term, the statement still remains void of key components needed to justify a further removal of accommodation; while improved from significant weakness at the start of the year, the committee remains incapable of proclaiming outright strength in the underlying economy with clear upward momentum in inflation, improved conditions for business investment or confidence in a sustained healthy pathway for the domestic economy going forward.

Without clear indication the U.S. economy is on firm, sustainable footing, the Fed will and should continue to exercise patience. After December's mishap, it is clear that preemptive policy moves (rate hikes) based on expectations of strength is not good enough, said improvement must be realized. While "some increase" in activity and "diminished" risks is a step in the right direction, there is no doubt the Fed continues to face unease surrounding the health of the domestic economy and concern regarding volatility abroad suggesting rates are likely to be much lower for much longer.

Commentary by Lindsey Piegza, the chief economist for Stifel, Nicolaus & Company, specializing in the research and analysis of economic trends and activity, world economies, financial markets and fiscal policies. Piegza joined Stifel in 2015 amid the merger with Sterne Agee where she served as chief economist. Previously, Piegza served as the economist for FTN Financial for eight years in NYC. Follow her on Twitter @lindseypiegza.

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