This week will be a busy one with Wednesday a key day as the release of the initial estimate of second-quarter gross domestic product and a statement from the Federal Open Market Committee at the close of its monetary policy meeting on July 29–30. On Thursday, the Employment Cost Index for the first quarter comes out. A number of reports will be released on Friday, including personal income, construction spending, the ISM Manufacturing Index, and the closely watched monthly employment situation.
This begs the question of when the Fed will raise interest rates, which we break down into three decision points:
- Economic Strength – Estimates for advance Q2 GDP is only 3.2%, which is a bit low considering the economy shrank -2.9% in Q1 of 2014. The cold winter may not have been all to blame as a larger snap back was expected. In summary, the economy is still fragile domestically and the rest of the world is still shaky as well.
- Inflation – It remains stubbornly low, and the recent retreat in commodity prices will not allow it to accelerate in the near term.
- Job Environment – This will be the most closely watched factor by the Fed in our opinion. If signs of wage pressure and growth accelerate this could be the main catalyst for rates to increase quicker than expected.
And so ultimately, we don’t see a rapid rise in short-term interest rates as a high probability. We do think they will slowly raise them in 2015, but it will be a multiyear process as they will have to reassess how vigorous the economy can withstand higher interest rates. We think the economy, like a drug addict, has become addicted to low interest rates and it will be difficult to wean them off this drug.