We know you’re focused on Greece, Portugal, Spain, and Goldman Sachs (GS) right now, but at some point today you should take a few moments to note that the Fed is meeting, and will thus induce a whole new round of nervousness into this market.
Mike O’Rourke at BTIG spells out the key things you need to think about:
The FOMC’s latest policy meeting occurs today and tomorrow. For nearly a year, FOMC meetings have been either uneventful or unimportant, or both. The most notable excitement was last November’s meeting when expectations rose that the FOMC might amend or drop the “exceptional and extended” (E&E) language. It was in that statement that the FOMC essentially locked in the E&E language by providing an explanation for it. The FOMC announced the interest rate decision by explaining that, “The Committee will maintain the target range for the federal funds rate at 0 to 1/4 per cent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.” The bold portion was qualifier language added at that meeting and has remained in subsequent statements to date. As the recovery now broadens beyond a Financial markets recovery to a real economy recovery, investors need to be prepared for the FOMC to take monetary policy off the auto pilot mode that it has been on for some time. As such, FOMC meetings and Fed speeches should garner heightened attention.
So, what would actually prompt the Fed to change its language and prepare markets for the tightening process?
There are a few key economic indicators heading to the red zone.
Here’s one noticeable “v” which suggests inflation in the offing.
Low capacity utilization has been central to the argument that inflation is basically impossible.
Beyond that, the Fed is watching:
- Unemployment (still very elevated).
- The CPI
- The employment cost index (which is ticking up again)
- Inflation expectations (still calm)
- Commodity index (ticking up again).
Right now, none of the indicators would require the Fed to move towards a more hawkish stance.
But! And here’s the kicker:
Retrospectively, all of the qualifiers the FOMC identified appear tame. Excess Reserves remain tethered to the Fed despite the exceptionally low interest rates. M2 is barely growing year over year. One other aspect we should note is the currently stalled Financial Regulatory Reform Bill, which moderates the Fed’s 13-3 emergency powers. Essentially, once the Fed begins a permanent unwind of its balance sheet, it may not have the flexibility to bring it back up should the need arise. The combination of these factors reinforces the current dovish stance the FOMC has taken and the slow unwind as described by Sack. The conversation does not end there, because the Fed must also look prospectively.
In the March meeting minutes released earlier this month, the FOMC removed the 6 month calendar expectation from E&E that FOMC members previously indicated. One could argue, that a indicate a shift in language has commenced. The simple fact is that the data warrants some type of language adjustment. The two key areas of weakness the FOMC members have highlighted during this recovery have been housing and employment. The most recent data on both fronts has shown early signs of light. One month’s data certainly does not make a trend, but revisions in both cases have been upwards and forward estimates are also in the positive direction. With economic data ramping up, the Fed can afford the luxury of shifting gear with words, especially since they do not have to follow through with action anytime soon. Since the Chairman has been so adamantly dovish recently, we cannot say that we know E&E will be altered or gone tomorrow (although it should be), but, at a minimum, we expect a baby step towards tighter language.
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