While the US’s non-farm payroll report for July was a bit stronger than anticipated, in its quest for the goldilocks economy, the US Dream Team still appears short of breath and in need of additional stimulants. 

The debate within the FOMC appears to be more about how to provide this stimulus rather than if, and we see a 65% chance of QE being announced at the September meeting. An idea gaining traction is open-ended QE, or QEX, in which the Fed would continue expanding its balance sheet until sufficient economic progress has been made. We see this option as potentially more effective than traditional QE. However, with only the more dovish members of the Committee so far prepared to publicly back this option, it is not yet clear whether the rest of the FOMC is on board. The Chairman’s speech at Jackson Hole at the end of August will be an ideal occasion for the Fed to make its intentions clearer.

Economic data in the coming week are unlikely to challenge the view that more QE is needed. Expect June’s retail sales to have posted only a modest rise after declining for two months, a forecast that is consistent with a subdued gain in overall consumer spending in Q2. Meanwhile, CPI inflation is likely to post another subdued reading, as a fall in energy prices, albeit at a slower pace than in June, offsets a moderate increase in core prices. Food inflation is likely to have remained fairly weak in July but we expect it to pick up later in the year, due to the impact of the severe drought in the corn belt. 

While in the very near term the bearish momentum suggests caution, our expectations for more Fed action are bullish for the 0-5y sector. Under a new QE programme, some expect the Fed to buy in the 5y sector of the curve, because the available supply at the long end has already been depleted during Operation Twist. The current Twist programme only involves buying in longer maturities, but it is difficult to continue this pace of buying without extending those purchases to the 5y sector.

Fed Losing Ground on its Mandates

Employment-Population Ratio not Improving

Nominal GDP Growth Has Been Weak

There Seems to be a Flow Effect