Fed State of Play: Headed for Sept Bal Sheet Cuts, 3rd Hike

--Solid Jobs Report Friday Paves Way for Sept Reinvestment Announcement

--Inflation Data Important Factor for Timing of Next Hike

By Jean Yung

     WASHINGTON (MNI) - Strong momentum in job creation and steady economic

growth will keep the Federal Reserve on course to start shrinking its balance

sheet after the September Federal Open Market Committee meeting and raise its

benchmark interest rate once more before the end of the year. 

     The Labor Department said Friday the economy added 209,000 jobs in July,

above analysts' expectations, and nudged the unemployment rate back to the

16-year low of 4.3%. Average hourly earnings also advanced 0.3% in the month,

keeping the 12-month gain at 2.5%. 

     Data from earlier in the week showed the year-on-year core personal

consumption expenditure inflation rate held steady at 1.5% in June. While

overall personal income was flat in the month, wages and salaries gained a solid

0.4%, according to the personal income and spending report Tuesday. 

     The Fed has already signaled that barring any unexpected economic

developments, the FOMC is likely to announce it will start reducing

reinvestments at the September meeting. Policymakers will get one more jobs

report before then, but the bar is low for beginning the long process of balance

sheet normalization.  

     The next interest rate hike -- which could come several months from now at

the December FOMC meeting -- will depend on continued job growth and some signs

inflation is returning toward target. However, labor market trends could weigh

more heavily on the minds of officials than the recent dip in inflation.

     San Francisco Fed Bank President John Williams and other officials

reiterated this week that gradual tightening is the right policy to mitigate

risks that come from running the economy too hot. 

     The unemployment rate was a 4.9% a year ago. A monthly average pace of new

payrolls of 180,000 in the past 12 months has brought the rate down to 4.3%.

Williams estimates its longer-run rate at roughly 4.75%. 

     "If job growth continues at this 180,000 number, we're going to see

unemployment just going further and further below and that will create risks,"

said Williams, who will have a vote on rates next year.

     "I just think we don't want to let this go too long because eventually

inflation pressures will emerge at some point," he told reporters. 

     He said he remains confident inflation should hit the 2% objective within

the next year or two and the recent softness has not prompted him to reevaluate

the third rate hike officials in June forecasted for the year. 

     "I do want to see inflation move up a little bit," he said. But, "I think

underlying inflation trends are positive." 

     Loretta Mester of the Cleveland Fed, who's also a voter next year on the

FOMC, similarly stressed, "We need to remain focused on the medium-run outlook."

     "If economic conditions evolve as anticipated, I believe further removal of

accommodation via gradual increases in the fed funds rate will be needed," she

said. 

     On inflation, she said she wanted to see more data to judge if there was

"something more" to the recent softness, echoing something several policymakers

have said for the past month. 

     St. Louis Federal Reserve Bank President James Bullard in an exclusive

interview with MNI this week warned that additional hikes may delay when the Fed

will hit its inflation target.

     "Given the inflation outlook, which has deteriorated in 2017, I would not

support further moves in the near term," Bullard told MNI. "It's possible data

will turn around, but we'll have to see. I think for now we should remain on

pause."

     Officials are unlikely to raise rates at the September meeting for that

reason, though they will update their economic projections at that time. 

     By December they should have a better handle on how much of the inflation

weakness is transitory. 

     With his forecast for no more rate hikes, the St. Louis Fed chief also

acknowledged he is "the most dovish person on the committee right now in terms

of the path for the federal funds rate."

--MNI Washington Bureau; tel: +1 202-371-2121; email: kevin.kastner@marketnews.com

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