Dollar Hollar: FED On Hold Ahead Of The Summer
The Fed still seems to be eyeing a summer hike, in all likelihood the Fed will hold rates steady at the March meeting currently underway; recent communication from Fed officials certainly do not suggest otherwise while the probability of a rate hike is just 4% according to futures market pricing.
The current low probability of a hike according to the market implied rate hike probabilities is relevant since the Fed wants to avoid big policy surprises at the current juncture. While the recent easing in financial conditions should have eased the committee’s domestic growth concerns, financial conditions tighten significantly earlier this year and policymakers probably want to see real GDP growth picking up before hiking rates. Meanwhile the global growth outlook is still a cause for concern. While market forecasts still favour Fed hikes in September and December, respectively, a summer move is conceivable too. In any event, better Fed communication is vital here since the gap between the Fed and the market is increasing. At today’s meeting, we may well get a hawkish dissent from Kansas City Fed president George.
The general tone of the statement will likely suggest that the Fed still is looking for policy normalization. While a number of officials may well vote for only two hikes in 2016, the median of the dot plots will likely suggest three hikes in 2016 and four hikes in 2017. In combination with Yellen likely acknowledging the recent better tone to US data at the press conference, consequently the path implied by market pricing may well move slightly higher.
The Fed will most likely prefer to see better growth before hiking rates; real GDP growth slowed to just 1% at an annual rate in Q4 but seems to have picked up to above 2% in the first quarter. Certainly recession risks have abated in recent weeks as US data has surprised to the high side and financial conditions have improved substantially, thus reversing the tightening seen in January and February. Moreover, the industrial sector is probably at an inflection point too; the most recent ISM manufacturing survey increased substantially and is expected to move back above the 50 level before too long.
Officials may still want to take some more time to assess the spillover effects from the tightening in financial conditions seen earlier this year. The global growth outlook is a cause for concern too and as such we do not expect the statement to reintroduce the balance of risk assessment that was taken out of the January statement. By contrast, if the statement says that the balance of risks are “nearly balanced”, it would be a strong indication that the Committee is paving the way for an interest rate hike within the next few meetings.
Many Fed officials have tied their forecasts of gradual interest rate hikes to inflation making progress towards the target. As such, recent news suggesting that core inflation is accelerating is an important piece of the puzzle. Core CPI inflation is well above 2% already while core PCE inflation is heading up too. Since core PCE inflation is already a tenth higher than the Fed’s year end forecast so the Fed may well need to revise its core inflation forecast higher in its new March projections, despite holding rates steady. While recent inflation readings have been on the high side, inflation expectations are still depressed.
In its December projections, the Fed was expecting the unemployment rate to hold steady at 4.7% in 2016, 2017 and 2018 respectively. Such stability just below the NAIRU level is pretty much unprecedented in the postwar period. Only on one occasion, in the late 1960s, can we find an episode that comes close. Instead what usually happens is that that the unemployment rate leveling out before moving sharply higher as the economy moves into the next recession. Markets aren’t pricing a recession in the cards, neither this year nor the next. Instead most participants find it likely that the unemployment rate will drop further below the NAIRU, although the rate of decline going forward will probably be much slower compared to the rapid decline seen in the past several years.
Over the past six months or so, discouraged people are returning to the labor force thus pushing the participation rate higher. This is why the strong job growth seen lately has not pushed the unemployment rate down much. In a nutshell, rising participation rates mean more competition for available jobs, which in turn suggests that wage pressures may be contained for longer even though the unemployment rate already falls within the Fed’s 4.8/5.0% NAIRU range. While the Fed still would need to hike rates, at the margin the risk of the labor market overheating is looking smaller now which is good news.
Technical & Trading Takeaways
From a technical and trading perspective the price action continues to develop in a complex consolidation pattern which has been frustrating bulls and bears since this time last year. We are still rotating around the apex of the pattern, against 98.50 the horizontal blue line on the chart, I would anticipate further exploration of the downside retesting 95.28 en-route to an ideal 94.00 symmetry swing objective. A bounce from the 94.00 level should meet resistance on a retest of the apex from below between 96.00/97.00 I will monitor intraday reversal patterns should this probable price path play out, setting shorts to target a full retest of the consolidation support at 92.50. A move through 98.50 against the current swing lows at 96.00 will negate this set up and I will reassess and update in the next report.
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