Keeping a first-half hike on the table.
The Fed will stand pat this week. We know it, they know it. So what then will the Fed talk about for two days?
The April meeting of the Federal Open Market Committee (FOMC) will be about the June meeting. Policymakers’ fundamental challenge is that the FOMC doesn’t want to rule out a June hike, but the markets already have. They need to decide if they want to make a play for a June hike and how to communicate such a message. They’ll probably want to keep the option for a June hike open and hence will alter this week’s statement accordingly.
The minutes of the March FOMC meeting dissipated any remaining mystery surrounding the April FOMC meeting:
“A number of participants judged that the headwinds restraining growth and holding down the neutral rate of interest were likely to subside only slowly. In light of this expectation and their assessment of the risks to the economic outlook, several expressed the view that a cautious approach to raising rates would be prudent or noted their concern that raising the target range as soon as April would signal a sense of urgency they did not think appropriate.”
While “several” participants thought April should be off the table, only “some” thought a rate hike then would be warranted. That “some” has likely turned to just a few now. Aside from the employment report, incoming data have not been particularly supportive for the hawks. GDP trackers from the Atlanta and New York Federal Reserves, for instance, suggest what appears again to be an anaemic first quarter. While this is likely just another instance of the recent curse of low growth in the first quarter and does not reflect underlying economic activity, the Fed still needs to wait for additional data prior to another rate hike.
So while April is out, what about June? June is tricky.
A lot of data become available between the April and June meetings—two employment reports, two personal income reports, multiple readings on inflation, etc. The Fed won’t want to write June off just yet. Indeed, I suspect recent comments by the normally dovish Boston Federal Reserve President Eric Rosengren challenging the market’s outlook for interest rates was driven in part to keep June open for a rate hike.
Such comments have been to no avail, however. Financial market participants place the odds at just 19.6 percent, according to Bloomberg data. Hence, if the Fed wants to “jolt” market participants from their complacency, they will need to modify the statement to signal that June is in play.
A strong signal would be something similar to that of last October, when the Fed made clear it was looking hard at December:
“In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation.”
There’s arguably too much caution, however, on the part of too many FOMC members to make such a strong statement regarding June.
But the Fed could send a weaker signal by reinstating the balance of risks with a neutral outlook. This, from December:
“Overall, taking into account domestic and international developments, the Committee sees the risks to the outlook for both economic activity and the labor market as balanced.”
How would such a decision be justified? There doesn’t appear room for much improvement in the economic outlook. From March:
“Information received since the Federal Open Market Committee met in January suggests that economic activity has been expanding at a moderate pace despite the global economic and financial developments of recent months. Household spending has been increasing at a moderate rate, and the housing sector has improved further; however, business fixed investment and net exports have been soft. A range of recent indicators, including strong job gains, points to additional strengthening of the labor market.”
This generally holds, although household spending should likely be downgraded from “moderate,” given personal consumption and retail sales numbers. Regarding inflation, the Fed said:
“Inflation picked up in recent months; however, it continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.”
Inflation numbers (both on PCE and CPI measures) are a tad weaker than in March. And likely more important to Federal Reserve Chair Janet Yellen, inflation expectations have not firmed. Instead, they have trended in the opposite direction, with some particularly significant moves in the New York Fed’s measure:
Calling attention to those moves would be particularly dovish, and I don’t expect the FOMC would do so in this statement. The weakness in such measures, however, will maintain an overall sense of caution regarding future rates hikes.
I suspect that, rather than the Fed focusing on the economy directly, a return of the balance of risk assessment will be based largely on firming financial market indicators. Since the March meeting, the dollar has weakened further, stocks have recovered from their declines at the beginning of the year, while both oil and market-based inflation expectations have held their earlier gains:
Plus, there are some signs of thawing in the corporate bound market, albeit mostly for higher-rated debt:
Overall, financial conditions have improved since the last FOMC meeting, and even more so relative to January. Meanwhile, the labor market continues to post solid job gains, and policymakers likely think the first-quarter GDP numbers are more an aberration than a trend. Hence the door is open for adding the “balance of risks” language back into the statement. And if the Fed wants to increase uncertainty about the outcome of the June meeting, it will walk through that door.
Bottom Line: Look for the Fed to hold steady this meeting, but be aware it is probably not comfortable with the market’s assessment of potential rate hikes this year. It will likely want to increase the uncertainty surrounding the June meeting in particular. The improving financial situation gives it room to do so by moving to a balanced assessment of risks. My view, however, is that September is more likely than June for an actual move—I tend to think it will still lack sufficient data for a June hike and instead will use that press conference to set the stage for September.
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