Fundamental Macro

The FOMC meeting today will be accompanied by just a short statement. Outside the quarterly press conferences, the meetings tend to be less market-moving, and this one shouldn’t provide any surprises in of itself, as the March statement made clear that April was not on the cards for lift-off.

However, unless the Committee choose to insert some new time-based guidance (which seems very unlikely, as they have been desperate to get out of this trap for a while now), this will be the first statement since probably 2009 that casts future policy as simply data-dependent. Given that, the focus will shift to the Fed’s interpretation of the latest data, and their thoughts on the outlook contained in the first two paras.

The big question this month is just how dovish they sound on activity (which has clearly disappointed in Q1 – we find out by how much in a couple of hours)? I think they will bey fairly cautious, not wanting to place too much weight on a qtr that was impacted by some one-off factors (weather, strike) and not put too much weight on the latest payrolls outturn. I think that means they don’t mess around with the forward-looking para, but just report the data. The adjectives they choose will determine the market response. It feels like quite a lot of the Q1 weakness is already discounted, but at the same time the extreme dollar positioning may still have some way to go in terms of risk reduction.

Below is my attempt at redrafting the March statement for April (deletions as strikethrough, new text as italics):

Information received since the Federal Open Market Committee met in JanuaryMarch indicatessuggests that economic growth slowed during the winter monthshas moderated somewhat. Labor market conditions have improved modestly, with job gains slowing somewhat and the unemployment rate remaining unchanged further, with strong job gains and a lower unemployment rate. A range of labor market indicators suggests that underutilization of labor resources continues to diminish. Household spending is rising moderately; declines in energy prices have boosted household purchasing power. Business fixed investment is advancing, while the recovery in the housing sector remains slow and export growth has weakened. Inflation remained has declined furtherwell below the Committee’s longer-run objective, largely reflecting declines in energy prices. Market-based measures of inflation compensation rose, butremain low; survey-based measures of longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to remain near its recent low level in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of energy price declines and other factors dissipate. The Committee continues to monitor inflation developments closely.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. Consistent with its previous statement, the Committee judges that an increase in the target range for the federal funds rate remains unlikely at the April FOMC meeting. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term. This change in the forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

This statement would leave June on the table for liftoff, but that seems a fairly low probability now. Having been split between June and September previously, I now put the most likely outcome as September, but with some weight on December. Weighing the activity and inflation outturns will be key. If Q2 growth disappoints (it is early days, and the initial indicators have been mixed) then September becomes less likely. However, with oil up 20% in April (although still down over 40% on a year ago), the drag on headline inflation will start to reverse, as core measures very steadily drift up. That should improve the Committee’s confidence in inflation rising to 2% in the longer-term.