It's only Monday, but already you'd think the Fed was the only game in town .....

Monday 19th March 2018

It's only Monday, but already you'd think the Fed was the only game in town .....

ref :- General

Sterling watchers would probably beg to differ  --  they've got Brexit developments, inflation data and the Bank of England to keep an eye on  --  but in an otherwise quietish week in the economic calendar, the US Fed's Open Market Committee's meeting and rate decision on Wednesday stands out a mile. Not the decision itself, you understand ...... that might now be termed "a foregone conclusion"  --  even though we're supposed to believe that there's no such thing in markets.

We cannot find a single commentator who does NOT believe that the Fed will hike rates by 25 basis points this week. The interest therefore  --  and it's all across the financial media who have little market action to report on a Monday morning  --  lies in what we'll learn about the Fed's expectations for futures rate rises, and whether new chairman Jay Powell represents continuity or something a less cautious.

Mr Powell's post-decision statement and press conference will reveal whether the Fed has changed it's forecast of a total of three hikes this year to four. On balance, the majority view still seems to be that they'll stick with three but the belief that the Fed may take a more hawkish position is growing, and is supported by some pretty high-profile players (Goldman Sachs, UBS).

In his first testimony to Congress back in February, Mr Powell acknowledged that the fiscal stimulus of $1.5 trillion in tax cuts and $300 billion in spending pointed to potential upgrades in growth and interest rate forecasts. There's also a suspicion that the new man may be less worried about adverse market reactions to a stronger Fed approach than his predecessor, Janet Yellen. That's a pretty big assumption at this early stage considering that Mr Powell was billed as the continuity candidate, and besides ..... it's likely that Ms Yellen would  have been open to upping her own expectations if she felt that such stimulus at a time of tight labour markets and decent growth ran the risk of overheating the economy.

Against that, not all indicators have been rosy. Poor retail sales data have caused Q1 GDP estimates to be marked lower, quite sharply in some of the more volatile predictions. First quarter economic performance has regularly proved disappointing in recent years. If the date does suggest something similar in 2018, they may not prove to be representative of the year as a whole (as has been the case in previous years) but they won't increase the chances of the Fed getting more aggressive at this stage.

In essence, the Fed's deliberations revolve around the same question as they have for some time now (even if the extra stimulus has exacerbated the situation) : stronger growth leads to tighter labour markets, which SHOULD lead to upward wage pressure and therefore to inflation. Does the Fed take that accepted wisdom on trust, and act pre-emptively to keep a lid on inflation and to stop the economy overheating ? Or does it hold back and after such a long period of low inflation, should it risk a little bit of an inflation overshoot by waiting for some actual evidence of it before acting ?

Apart from examining the language of the Fed statement in minute detail and drawing every nuance (real or imagined) from what Mr Powell has to say, the markets will be desperate to see the so-called "dot-plot", the representation of the interest rate expectations of individual members of the FOMC, and the (upward) adjustments to growth expectations that the Fed is now basing policy on. And something that is being much discussed is whether the Fed will raise its assessment of the "neutral" rate of interest, which effectively is the rate that will neither accelerate growth nor slow it down. If that number is raised, it suggests that the longer term target for the Fed's interest rate "normalisation" process might be higher than we had been thinking . They'd be very happy if that was the case .... it would give them more ammunition to cut rates when the next recession comes around.

Any particular market action revolving around the Fed speculation this morning ? Well, the perception that chances of a more hawkish Fed stance have increased have supported the dollar (except versus sterling) and been something of a dampener for stocks and bonds. Interestingly, the one "taking head" that we had a chance to listen to this morning suggested that such action was reasonable, and will be supported by hawkish noise surrounding the Fed on Wednesday ...... BUT ...... in actuality the Fed will manage only a total of three hikes this year and consequently after a short period of strength (a matter of weeks), the downtrend for the US unit will be resumed. 

That would run contrary to the majority view of earlier in the year that saw continued dollar weakness before strength later in the year .... but it's no less legitimate an argument for that.