The ECB talked about diminishing downside risks, at least to growth. In the US, the Federal Reserve faces materializing downside risks. Will it ignore them for now in hope they are blips? Or acknowledge the downturn, shut the door on a June hike and send the dollar down?
Here is a preview of the May 3rd meeting with three scenarios.
Dovish hike in March
Back in March, they announced a rate hike to a range of 75-100 basis points. The hike was well telegraphed, but the tone was a downside surprise.
Yellen and her colleagues raised rates for the second time in three months, a quicker pace than the full year separating the first and second hikes. However, this was not accompanied by a revision of the outlook. The dot-plot still implies three hikes in 2017, growth forecasts were left unaltered and there was one dissenter, Neel Kashkari. The US dollar fell on that dovish hike.
Since then, Fed officials have sent mixed messages according to their biases, but they sounded relatively optimistic about fulfilling the rate hikes.
How’s the economy doing?
In one word: meh.
The economy grew at an annualized pace of only 0.7% in Q1 2017. This first assessment put quarterly growth at the lowest level in three years. The underlying figures have not been too upbeat: retail sales, durable goods orders and some housing measures have missed expectations.
What about the soft data? Contrary to the “hard data” (what actually happened in the past), the “soft data” (surveys about the future) have been more optimistic. But also these soft figures have softened: a weaker ISM Manufacturing PMI followed weaker consumer confidence.
Fed mandates still good, but
The Fed has two mandates: employment and inflation. The most recent Non-Farm Payrolls report consisted of weak job gains: 98K. On the other hand, it showed that wages are up 2.7% y/y – a healthy pace. This can support the theory of full employment. With fewer employees looking for jobs, job gains slow down but wages are on the rise.
Others doubt that with a participation rate of 63%, we can already see full employment. The theory will be put to a test on Friday with the latest NFP data.
And how about inflation? Here things are less ambiguous. The Fed’s favorite inflation measure was released this week and it shows subdued price rise: 1.6% y/y in the Core PCE Price Index. That is down from 1.8%. So, if the Fed sees 2% as a ceiling for inflation, we are still very close. But if that is a target that can also be surpassed, there is room for more accommodative monetary policy.
All about a hint for June
The Federal Reserve is not expected to change the interest rates this time. While Fed Chair Janet Yellen and her colleagues often state that every meeting is a live meeting, this one is not one where announcements are made. The May meeting does not consist of new forecasts, the dot plot nor a press conference from Yellen.
So, we will only receive the statement. Comments about inflation, employment, growth, and dissent will be scrutinized for any hints about the next move of the Fed.
Three scenarios
- Data dependent: In many cases, the Fed prefers not rocking the boat, waiting for more data to emerge. This may be the case once again. So, Yellen and co. may opt for keeping the statement mostly unchanged, expressing optimism about employment, caution about inflation and a message of being “data dependent“. They will already let us know in early June. This scenario has a high probability and the dollar will not go anywhere fast under such an outcome.
- Dovish: Given the current worries about inflation and employment and a future downturn resulting from lower growth, the Fed could acknowledge the worsening situation. In this case, it would serve as a hint about June: no hike in that meeting. With current hiking expectations, the greenback could fall. This scenario has medium to high probability.
- Optimistic: While this is unlikely, maybe the Fed knows something about employment that we do not know yet. They could shrug off the poor Q1 growth as seasonal, the recent NFP miss as a one-off and express an upbeat view on future inflation. In this scenario, the dollar has room to advance as the odds for a June hike will rise.
Fed Preview Conclusion
The is unlikely to rock the boat, but with weak data, there is a better chance of tilting to the downside.
What do you think?
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