June 2000 Credit Market Review
The FOMC voted to leave policy unchanged at its most recent meeting, with the proviso that additional rate hikes may be necessary if the labor market does not cool. Anecdotally, we see no evidence of the latter. We believe that the current Fed tightening cycle is more than likely over. But for this to be true, the economic moderation that was evident during the spring must persist for the remainder of the year. After growing at a 5.5% rate in the first quarter, GDP probably rose at a 3.5% rate in the second quarter. That 3.5% GDP growth rate is well within the Fedís estimate of a 4% non-inflationary growth potential. However, the FOMC may move to head off any prospective wage/inflation pressures by raising rates one more time, contrary to many economists perspectives.
In leaving monetary policy unchanged on June 28, the Fed acknowledged that growth has slowed, but expressed uncertainty as to whether that slowing would be sustained. Because of that uncertainty, it felt that risks were still weighted toward inflation. Before the Fed signal will signal an all clear, it needs to see further evidence of moderation. Two full sets of economic data will be released between now and the August 22 FOMC meeting. For the Fed only three reports are truly crucial: employment, retail sales and the CPI. The labor market canít tighten further, consumer spending needs to remain on a more moderate path, and core inflation must remain contained.
Interest rates were affected by the most recent Fed inaction. The one-year T-Bill fell from 6.30% to 6.02% during the month of June. U.S. Government Agency Discount Notes also dropped 15 to 25 basis points across the short end of the curve. The shape of the yield curve is beginning to take on a more normal shape after months of a steep inversion. In order for the curve to return to normal one of two things must happen. Short-term rates must fall or Long-term rates must rise. So far the former has prevailed and will more than likely continue this trend as long as inflationary pressures remain subdued.