The September Federal Open Market Committee (FOMC) meeting is shaping up to be a real cliffhanger. The minutes of July’s meeting didn’t give a clear signal regarding the September move for a rate hike. It is clear, however, that the participants are not in agreement yet. The Fed’s downside risks have increased since their meeting in July: Oil and commodity prices have declined further, and economic and financial developments abroad, especially in China, have deteriorated. We believe the odds for a liftoff have shifted to December from September, though it remains a close call given that domestic economic data since the July meeting continue to be more positive than negative.

The economic releases this week include:

• Housing starts grew 0.2% to an annual rate of 1.206 million in July (the highest since October 2007) from a revised 1.204 million (was 1.174 million) in June. The rise in starts was driven by a sizeable gain in single-family starts, up 12.8% to 782,000–the highest since the end of 2007. Multifamily starts fell 17.0% to 424,000, though this comes on the heels of a surge in June. Building permits, a forward-looking indicator of starts, fell 16.3% to an annual rate of 1.19 million in July after jumping to 1.337 million (was 1.343 million) in June.
• Existing home sales climbed 2% to an annual rate of 5.59 million in July–an eight-year high–from a downwardly revised 5.48 million (was 5.49 million) in June. On an annual basis, existing home sales climbed 10.3% in July–the 10th consecutive month of growth. Inventories fell to 2.24 million homes available for sale, representing a historically low 4.7 months at the current sales pace.
• The National Association of Home Builders/Wells Fargo Housing Market Index ticked up one point to 61 in August. Both the current-sales index and the prospective-sales index hit their highest levels in nearly 10 years. However, the index for buyer traffic remains low at 45 (indicating that more than half of the builders think buyer traffic is still low).
• The Consumer Price Index (CPI) edged up 0.1% in July after climbing 0.3% in June. The core CPI (excluding food and energy) ticked up 0.1% in July following a 0.2% increase in June. Consumer prices were up 0.2% year over year in July, while the core CPI grew 1.8% year over year.
• The Empire State Manufacturing Index tumbled to negative 14.9–a six-year low–in August from positive 3.9 in July.
• The Philadelphia Fed Manufacturing Index rose to 8.3 in August from 5.7 in July.
• U.S. leading economic indicators fell 0.2% in July, after rising 0.6% in June. Eight out of 10 components of the leading index made positive contributions in July. The biggest gain, as usual, came from the interest-rate spread. The only large negative was the contribution from building permits, which pulled back sharply in July after three months of solid gains.
• Initial jobless claims edged up to a seasonally adjusted 277,000 in the week ended Aug. 15 versus 273,000 (was 274,000) the week before. The four-week moving average rose to 271,500 in the week ended Aug. 15 from 266,000 (was 266,250) the week before. Continuing claims fell to 2.254 million in the week ended Aug. 8.

A Higher Hurdle To Clear

The July FOMC minutes released on Aug. 19 indicated less conviction among Fed members on their two mandates, which left markets guessing on the Fed’s next move. The minutes said that “most judged that the conditions for policy firming had not yet been achieved, but they noted that conditions were approaching that point.” With FOMC members relatively convinced that the jobs market was strong enough for them to initiate a hike, they weren’t “reasonably confident” that inflation outlook was improving. Finally, the minutes highlighted more division between committee members and less conviction in discussions on labor and inflation–not a unified front when they decide on when to initiate the first rate hike in almost 10 years.

Even member agreement on an improving jobs outlook had caveats. FOMC participants agreed that “labor market conditions had improved further” with “many” voters thinking that slack “would be largely eliminated in the near term” if their forecasts were realized. But not everyone agrees with that rosy outlook. “Several” members contended that “some noticeable margins of slack remained.” And while several saw “labor market conditions as at or very close to” maximum employment, others were concerned that “maximum employment could take longer to achieve, noting, for example, the lack of convincing signs of accelerating wages.” That doesn’t bode well for agreement on when to move.

The inflation outlook was even more muddled in the July minutes. While “most” participants still thought that the downward pressure on inflation from low energy prices and a strong dollar would “prove to be temporary” and that inflation would increase to the committee’s objective over the medium term, some participants disagreed, noting that “incoming information had not yet provided grounds for reasonable confidence that inflation would move back to 2% over the medium term” and that the inflation outlook thus “might not soon” meet conditions needed to initiate a firming of policy.

Still, they did agree on one thing. “Almost all members” said that they need more evidence that economic conditions had “firmed enough for them to feel reasonably confident that inflation would return to the committee’s longer-run objective over the medium term.”

While the Fed has not ruled out a September hike, the bar has been set a bit higher than earlier thought. It seems that the “burden of proof” is on September’s shoulders. Incoming data now needs to support a September hike “beyond a reasonable doubt,” rather than strongly argue against it. Overall, we believe the odds for a liftoff has shifted to December, though we’ll still be keeping our eyes on the incoming news to see if the needle moves closer to a September move. Given a more divided committee, we suspect there will be a few dissents either way.