Since the Federal Open Market Committee is not going to be raising rates at its April 27-28 meeting next week, the only real question is whether the Committee will use the April statement to signal a hawkish lean towards a June meeting rate hike.
*** On balance, we believe the FOMC probably will find a phrasing to include in the statement next week to indicate their lean towards a possible June rate hike. Or at least it is our sense there is a Committee majority going into the meeting wanting to signal such a probability, as a first step to spur less dovish market pricing of the Fed’s rate path. And it remains our sense a fairly solid Committee majority is indeed still eyeing June for a second rate hike in the policy normalization path (SGH 3/11/16, “Fed: A Messaging Template”), assuming the data stay on track and there is relative market calm. ***
*** That debate over signaling will invariably center around the balance of risk assessment between a sense of diminished global risks since the March meeting versus an uncertainty whether a first quarter softness in domestic economic activity is a repeat of seasonal factors again or a sign of a more sustained slowdown. While caution in being so near the zero lower bound remains, we suspect the Committee will put its faith in the baseline forecast for just above trend growth and a slow rise in inflation through the rest of this year, lending to some fashion of a hawkish signal in the statement language. ***
*** The issue is more about timing than intent, in that there isn’t really enough clear data to fall back on at the April meeting to flag a June hike with any certitude. We suspect simply acknowledging that economy activity has slowed but that it may be due to “transitory” factors, and either deleting or diluting the March sentence that “global and financial factors continue to pose risks” may have to do the heavy lifting in the April messaging. But perhaps that will be enough to spur a market re-pricing about June probabilities until late May, when Chair Janet Yellen could signal the FOMC’s June rate intentions in a high profile speech or testimony. ***
First Quarter Weakness
There is a certain irony that in contrast to the exact opposite just a few weeks ago, it is the US that may now be showing signs of weakness while the global picture looks marginally better or at least less threatening. Indeed, there was a fair lifting of the gloom over global growth risks at last week’s International Monetary Fund/World Bank meetings in Washington, especially about China (see SGH 4/20/16, “China: G20 Postscript on Fed, RMB, and Credit Downgrades”).
In part, perhaps the Fed can claim some bragging rights to helping ease those risks. Whether by default or by design, the Fed’s lower projected rate path from four to two rate hikes this year did more than any other policy move worldwide to ease the overall tightening of financial conditions and exchange rate and capital outflow pressures that were building in China. (As an aside, in case Berlin did not get the memo, the policy moves by the Fed and Beijing were meant to put a premium on fiscal over monetary policy in Europe.)
But just as financial and global risks look to be significantly diminished, there is suddenly increasing concern across the Fed that the first quarter slowdown in domestic economic activity may be more sustained this time.
It turned out last year’s first quarter slowdown was primarily due to seasonal factors, followed by a solid rebound in the second quarter and a steady, above trend growth through the rest of this year. And that same rinse and repeat cycle remains the FOMC’s base case forecast in the March Summary of Economic Projections.
But there is nevertheless no small degree of nervousness among many Fed officials in an unusually weak personal consumption running quite a bit lower than previous first quarters, while measures of consumer confidence and consumer expectations are both leveling off. Retail sales numbers are also coming up a bit short of expectations, though there is apparently an effort to dig into the raw numbers to gauge whether some of that is in part simply capturing the lower costs of gasoline sales at the giant nation-wide discount chains like Wal-Mart, Costco, and Sam’s Club, which all operate gasoline stations at their locations.
A related complication is the ongoing uncertainty over how the inflation dynamic is likely to play out this year, especially as the recent rise in oil prices looks to have stalled or could even reverse in light of the talks among oil producers having gone awry in Doha (SGH 4/17/16, “Oil: Doha Collapse”).
One bright spot is housing, which is finally providing a definite tailwind to growth, despite underwriting standards that remain relatively tight. House appreciation is up, rent growth remains strong, and there looks to be a decent demand for new home construction. And of course, the job engine looks to still be tightening up the labor market slack, however soft the broad aggregate GDP numbers may look.
But even on both these two fronts there is a worrying catch in that, for instance, housing accounts for a much smaller portion of the US growth, so it is less of a net boost to growth than in the past. And what’s more, there is also some early indications in the Federal Reserve Bank of Kansas City’s labor market index of ebbing momentum in job growth. Of course, the pace of job growth is supposed to be slowing as the headline unemployment level reaches to and through just about everyone’s estimates of NAIRU, but still, it is not entirely clear what is happening until there is at least another month’s worth of employment data.
All of this is another way of saying a clearer picture on the first quarter probably won’t become available until well into May, or in other words, certainly not by next week’s meeting. Without any of the valued confirming evidence in the data before them next Tuesday and Wednesday, the FOMC will have to trust the forecasts and the underlying assumptions, and just run with them.
April as a Messaging Bridge
So despite a lower global and financial risk hanging over US growth, there is enough uncertainty over the near term outlook to probably rule out the FOMC adopting rate hike language as explicit as they did in October last year when they inserted the “in determining whether it will be appropriate to raise the target range at its next meeting” language that was meant to hit the market over the head with a two by four.
The easiest messaging language the FOMC could take next week would be to revert back to an explicit risk assessment – the signaling of “nearly balanced” is certainly a convenient, off the shelf messaging device — but we sense a hesitancy to do so for reasons not entirely clear. But there are a number of language options available to the FOMC wordsmiths in the April update to the formal policy statement.
The cleanest and most honest would be to simply state in the opening descriptive paragraph on the state of the economy that activity has indeed slowed these last few months, but that it may or even probably is due to transitory or seasonal factors. That is what the FOMC opted to put into last year’s April statement when they faced the same uncertainty on the near outlook.
The same straightforward statement language would be to dilute or delete altogether the loaded language from March that “global and financial factors continue to pose risks” since, well, they don’t as much for now.
And there is probably a majority of the Committee who feel that would probably be enough to nudge the market pricing to a higher June move probability with which the Fed would feel more comfortable, without making an explicit commitment yet.
Indeed, there is a fairly convincing case that is likely to be made in the Committee discussions next week that while the FOMC would like to avoid an entirely neutral statement – i.e., it would probably push the market pricing out of June and probably out of all of 2016 — it is also simply too early to go very hard on the April signals about June rate intentions.
Instead, the April statement language is we suspect more likely to serve as a messaging bridge to nudge the market’s pricing probabilities a bit higher until the May data provide a clearer picture on the outlook. In that case, a mid to late May speech or testimony by Chair Yellen herself would then become the primary and essential messaging vehicle to shape market expectations.
And after how dovishly the market took her enormously influential Economic Club of New York speech last month, only the Chair herself will be able to bend market pricing towards a higher probability of a June rate hike.