FOMC preview FOMC to downplay Q1 data weakness

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1 Investment Research General Market Conditions 27 April 2015 FOMC preview FOMC to downplay Q1 data weakness The April FOMC meeting concludes on Wednesday 29 April and the FOMC statement is released at 20:00 CET. There will be no press conference or updated projections. The tone of the speeches since the March meeting has been mixed, but the most relevant speakers, Fed Chair Janet Yellen, New York Fed President William Dudley and Vice- Chairman Stanley Fischer, have in general signalled that they expect current weakness in US data to be partly temporary. However, in particular, Dudley has been clear that the recent run of data has increased the uncertainty around the outlook for growth this year. We expect the statement to acknowledge the weakness in recent data but to emphasise that the Committee still views the soft patch in US growth as caused at least in part by temporary factors. While activity data has been weak, inflation data has surprised on the upside with core CPI up 0.2% m/m in both February and March and PCE core inflation (the preferred measure by the FOMC) set to post a similar trend. The statement is thus likely to note that inflation has stabilised lately. We expect the statement to leave the paragraph on the economic outlook unchanged and repeat that 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. The FOMC would like to break completely free of calendar-based rate guidance and we do not expect the paragraph that an April hike is unlikely to be replaced with guidance on what to expect for the coming meeting on June. Although the changes to the language are not major, we could see an upward move in rates following the statement. During March, market participants have adjusted their expectations of a first fed funds rate hike from October to December/January as data has continued to disappoint. If the FOMC downplays the weakness in data, as we expect, and acknowledges the latest stabilisation in core inflation, we believe the statement will push US rates higher and data released over the coming week should also work in that direction (see Weekly Focus: Riksbanken to add fuel to the currency war). We are currently awaiting the next and likely final leg of USD strength and the FOMC this week could sow the seeds for this. Currently, investors appear somewhat reluctant to buy into more dollar upside following recent weak US data and stretched long USD positioning. The FOMC will likely in itself not be enough to trigger more than a temporary blip in EUR/USD though. As we have argued previously, we probably need to see surprise indices shift clearly in favour of the US vs. the euro area for EUR/USD to initiate a trip to below parity as we call for in six months. The FX market will clearly stay alert to any Fed comments on the USD but if we are right that the FOMC will signal that it is not taking part in a currency war, the scene is set for a healthy April payrolls report to become the catalyst for a EUR/USD sell-off. We are short EUR/USD in our Danske FX Trading Portfolio, see Danske Bank FX Trading Portfolio: Sell EUR/USD. Senior Analyst Signe Roed-Frederiksen sroe@danskebank.dk Senior Analyst Christin Tuxen tux@danskebank.dk Important disclosures and certifications are contained from page 7 of this report.

2 FOMC chart book Labour market in one chart - most labour market indicators are at better levels than at the beginning of the 2004 hiking cycle Leading Temporary help services employment Payroll employment June 2004 June 2014 March 2015 Job openings Employer behavior Unable to fill job openings Hires Initial claims Hiring plans Job finding Job availability Utilization (slack) Part time for economic reason Marginally attached Unemployment Quits Confidence Note: The diagram shows the level of tightness of different US labour market key figures at different times, compared with the level of the same figures in June 2004 (index=100). Counter cyclical figures (unemployment rate, jobless claims, marginally attached and work part time for economic reasons) are inverted; thus, the higher index (the further from the middle) the better (tighter) is the state of the labour market JOLTS data for December is an average of October and November data. Source: BLS (JOLTS), Macrobond Financial QE halted in October, next is a hike in the Fed funds rate Fed funds rate expectations have moved lower since March Source: Federal Reserve, and Danske Bank Markets Source: Federal Reserve, Bloomberg and Danske Bank Markets 2 27 April

3 Core inflation is running below Fed s comfort zone......but has stabilised lately Source: BEA and Danske Bank Markets Source: BEA and Danske Bank Markets Market inflation expectations have dropped but survey based measures are stable Source: Federal Reserve of Philadelphia, Macrobond, University of Michigan and Danske Bank Markets Source: Federal Reserve of Philadelphia, Macrobond, University of Michigan and Danske Bank Markets Job growth slowed significantly in March Consumers remain upbeat on labour market developments Source: BLS and Danske Bank Markets Source: BLS and Danske Bank Markets 3 27 April

4 Unemployment gap is getting smaller......but wage inflation remains subdued Source: BLS, CBO and Danske Bank Markets Source: BLS and Danske Bank Markets Business confidence mixed as manufacturing struggles Consumer confidence at cycle highs Source: ISM and Danske Bank Markets Source: University of Michigan, Conference Board and Danske Markets Personal spending got a boost from lower oil prices......but not as much as expected in Q1 Source: BEA, Federal Reserve of St. Louis and Danske Bank Markets Source: BEA, Federal Reserve of St. Louis and Danske Bank Markets 4 27 April

5 House prices have ticked higher but sales pace remains slow Mortgage and corporate funding costs are still very low Source: NAR, U.S. Census Bureau and Danske Bank Markets Source: Moody s, MBA, Federal Reserve, Eurostat and Danske Bank Markets Statement from 18 March Information received since the Federal Open Market Committee met in January suggests that economic growth has moderated somewhat. Labour market conditions have improved further, with strong job gains and a lower unemployment rate. A range of labour market indicators suggests that underutilisation of labour 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 has declined further below the Committee's longer-run objective, largely reflecting declines in energy prices. Market-based measures of inflation compensation remain 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 labour 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 labour 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 two percent over the medium term as the labour 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 two percent inflation. This assessment will take into account a wide range of information, including measures of labour 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 5 27 April

6 further improvement in the labour market and is reasonably confident that inflation will move back to its two 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 mortgagebacked 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 two 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. Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Jeffrey M. Lacker; Dennis P. Lockhart; Jerome H. Powell; Daniel K. Tarullo; and John C. Williams April

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