The Federal Reserve meets this week to discuss the state of and outlook for the economy and monetary policy.
“The economic data have been mixed since the FOMC last met in January, with a continued slowing in the growth rate of activity balanced by very strong payroll employment gains,” Goldman Sachs’ David Mericle said on Friday.
“Despite the continued improvement in the labour market, inflation has fallen further below the Fed’s target and wage growth has yet to pick up.”
As if the Fed’s job wasn’t already complicated, we’re also experiencing a huge rally in the US dollar, which has been deflationary for imported goods while making US exported goods more expensive to the rest of the world.
On balance, most economists continue to agree that the Fed will begin tightening monetary policy via interest rate hikes in June, if not soon after.
For now, economists and Fed-watchers will watch closely for minor tweaks in the Fed’s March 17-18 meeting language that could signal if rate hikes are coming sooner or later.
Here’s your Monday Scouting Report:
“Patient” is dead. The Fed has used the word “patient” to characterise its willingness to wait before it begins to hike rates. But thanks to the improving economic data, most economists believe the Fed will drop the word “patient” from its language, signaling a somewhat greater sense of urgency to hike rates.
But dropping the word patient is no guarantee that the first rate hike is coming in June. Here’s Goldman Sachs’ David Mericle: “In recognition of the improvement in labour market conditions and in line with its “mid-2015” guidance, the FOMC is likely to drop its “patient” forward guidance at the March meeting. The replacement language is likely to indicate that it will soon be the case that an increase in the target range could be warranted if the Committee is reasonably confident that inflation will move back over the medium term toward 2%. Such a change would imply that a June hike is in play, but is not a foregone conclusion…“
“…Looking beyond the March meeting, the key question is when FOMC participants are likely to be “reasonably confident” that inflation will return to the target over the medium term. We expect core inflation to decline another 20bp to 1.1% by midyear and consequently think that the Committee will ultimately decide not to lift off until September.”
- Empire Manufacturing (Mon): Economists estimate this regional manufacturing index climbed to 8.0 in March from 7.8 in February. Here’s Nomura: “The Empire State index declined in February, and set the tone for a generally weaker round of regional manufacturing surveys in that month. Declines in the new orders measure in this report in February provide less support for activity in the NY region in March. In addition, we expect to see the effects of inclement weather which started in the latter half of February to show up in this report.”
- Industrial Production (Mon): Economists estimate industrial production climbed by 0.2% in February as capacity utilization increased to 79.5%. Here’s Credit Suisse: “Extreme cold weather in February should boost utility output, helping headline IP rise a solid 0.5% m/m. Broad declines in business surveys, a tick down in auto production schedules, and sluggish worker hours from the payrolls report suggest core manufacturing growth should be more subdued. While oil output should continue to hold up, declines in rig counts create some downside risk for the broader mining category.”
- NAHB Housing Market Index (Mon): Economists estimate this homebuilder sentiment index improved to 56 in March from 55 in February. “Homebuilders reported that poor weather conditions weighed on activity in February,” Bank of America Merrill Lynch economists said. “This should reverse with better weather in March and the beginning of the spring selling season.”
- Housing Starts (Tues): Economists estimated the pace of starts declined 1.6% to 1.048 million units while the pace of building permits issuance climbed 0.5% to 1.065 million. “We suspect that poor weather conditions held back building, particularly in the Northeast,” Bank of America Merrill Lynch economists said. “Moreover, single family starts have outpaced permits, suggesting some capacity for further correction in starts. However, looking past the short-term weakness, we expect an upward trend in homebuilding to resume amid stronger demand for housing, both ownership and renting.”
FOMC Rate Decision (Wed): The Federal Reserve will publish its FOMC statement at 2:00 p.m. ET, and that will be followed by a press conference. Continuing on what Mericle said above, here are Bloomberg economists Josh Wright and Carl Riccadonna: “If “patient” were to remain, the Fed would be making a soft commitment not to raise rates for the next two meetings, taking June off the table. This is the framework Yellen has laid out in her recent Congressional testimony and the press conference following the December FOMC meeting. Yellen and others have noted that inflation data are lagging and monetary policy must be forward looking, and they seek mainly to be “reasonably confident” that inflation will return toward the 2 per cent target over the medium term — not that inflation actually needs to rise meaningfully — before raising rates. The sustained strength in labour market data suggest that it is time to lose “patient.”
“There has been no strong hint that the Fed would add any other language to offset a removal of “patient,” consistent with the notion of moving to a meeting-by-meeting regime. It is possible that the FOMC would choose to soften the change by making more dovish hints about the post-liftoff path of policy, but that seems unlikely for two reasons:
“First, the latest FOMC minutes suggest that there is still a fair amount of disagreement among Committee members about what the post-liftoff path should look like. Second, there is the simple fact that the market already projects a significantly flatter policy path than the Fed itself does, as evidenced by the Summary of Economic Projections (SEP).”
- Initial Jobless Claims (Thurs): Economists estimate the weekly jobless claims climbed to 295,000 from 289,000 a week ago.
- Philadelphia Fed Business Outlook (Thurs): Economists estimate this activity index climbed to 7.4 in March from 5.2 in February. From Nomura: “The Philly Fed manufacturing index fell by 35 points between November and February as activity appeared to fall in the Philadelphia region to start the year. In addition, the recent declines in energy prices and prospects of weaker global growth may be negatively impacting business sentiment. We may also see inclement weather further impact this report in March.”
Deutsche Bank’s David Bianco has been warning clients to prepare for a “near-term 5-9% dip” as, among other things, the Fed prepares to hike rates and the US dollar continues to strengthen.
In an FAQ for clients, Bianco answer the question: “How will equities (PEs) and long-term interest rates react to Fed hikes?”
His response: “We think the Fed hikes through 2016, but will signal intentions not to exceed 2% unless unit labour costs accelerate. Hikes can help limit the climb in LT yields and flatten the curve through 2016, if a stronger dollar keeps US inflation low and global real interest rates stay 0-1%. We think this hiking cycle is nothing like any experienced before and the key to PEs will be how LT yields react. But in the meantime, EPS risk remains to the downside on FX, whereas the debate on magnitude of Fed hikes and how bond yields and PEs react will last all year.”
Two years ago, Bianco did a very comprehensive study on what happened the last 15 times the Fed tightened monetary policy. You can read about it on BusinessInsider.com.
For more insight about the middle market, visit mid-marketpulse.com.