What Fed Will Signal at Meeting Next Week

The Federal Reserve is highly unlikely to raise rates at its policy meeting next week. The view that the event will be a snoozer, with little potential to move markets significantly, is reinforced in two ways: the semi-annual report to Congress on monetary policy by Chair Jerome Powell last week that involved comprehensive written submissions and hours of Q&A; and because the meeting on July 31 and Aug. 1 will not be accompanied by a news conference or the release of new economic and policy projections (including the “blue dots”).

Yet this sense of quiet may be too partial. Central bank officials face a series of delicate internal judgment calls about the economy and the path of both interest rates and balance-sheet policies. They must decide whether to tweak their prior market signals on four issues in particular.

Although domestic growth and inflation have been picking up in line with Fed expectations, the overall operating economic and financial environment is uncertain in several respects. For example:

• Financial market behavior continues to confound: A relatively flat yield curve has a differential between 2- and ten-year government of only 30 basis points, a level that in the past has signaled a significant economic slowdown.
• Trade policy is also unusually fluid, with the U.S. and its major trading partners engaged in actual or threatened tit-for-tat tariff escalations. Rather than maintaining upward momentum, wage growth decelerated in June, according to the latest employment report, despite another month of robust job creation.
• The accompanying uptick in labor-force participation resurfaces the notion that there may still be some slack in the jobs market despite a historically low unemployment rate.
• Productivity trends continue to puzzle economists. There is still too little to determine with confidence whether the persistently sluggish data are due to mismeasurement and various timing/temporary issues or dampening secular forces.
• Finally, growth momentum outside the U.S. seems to be losing steam, threatening America with economic and financial headwinds.

Open Market Committee members will have all of this in front of them when they assess their economic and policy baseline, and decide what to signal to markets. Speculation about possible tweaks was fueled last week by an intriguing last-minute change that Powell made to his previously circulated written statement to lawmakers on July 17: He added the qualifier “for now” to a routine phrase about the Fed’s intention “to keep gradually raising the federal funds rate.”

1. Traders in the equity market, though not in all other markets, interpreted this tweak as the sign of a somewhat more dovish tone in the Fed’s policy intention. The central bank must now decide whether to confirm this by signaling that it is:
2. Taking its baseline for the total number of rate hikes in 2018 back to three from four because of less accommodating international conditions;
3. Reducing the likelihood that the next hike will be in September; Suggesting an earlier endpoint for the balance-sheet reduction process, which would leave the Fed with an overall balance sheet that is still notably high in historical terms; and
4. Reinforcing the view that the neutral rate is highly time variant and is reverting back to a higher and historically more consistent level.

As I have argued before, I believe the FOMC led by Powell’s predecessor, Janet Yellen, would have jumped at the opportunity to signal all four given the uncertain operating environment. I suspect that Powell’s committee may be willing only to signal the first two items at this stage. But that does not mean it may not eventually point to the others. It will just take some time.

— For more Bloomberg Opinion columns, visit http://www.bloomberg.com/opinion.

Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. His books include “The Only Game in Town” and “When Markets Collide.”