This week’s FOMC meeting not only marks the first of eight meetings in 2020 but also the first time Jerome Powell faces both media and markets since the phase one trade deal was signed.
Since the December meeting, when the Fed held rates in the 1.5-1.75% target range, not only have trade tensions reduced but business confidence has rebounded and the labour market remains firm. However, economic activity remains mixed.
The ISM manufacturing index remains substantially below the breakeven 50 level, while factory orders and durable goods purchases continue to print negative. While this is lagged data and may show a marked improvement in the coming months due to the purchasing agreement struck with China, it compounds Powell’s statement from the December meeting that “there’s actually more slack out there”.
Growth data is expected to show the US economy slowed into year-end as per the cooling of consumer spending in Q4.
The Fed projects economic growth will slow to a 2.0% annualised rate in 2020 while the median private forecast is much more pessimistic at 1.8%.
It must be noted, however, that these projections can be revised substantially depending on the rebound in consumption activity, which may receive a helping hand should Trump come good on his fiscal expenditure promises announced at Davos last week.
Chart: Current data suggests the US economy has cooled more than official measures show
Powell’s outlook on the economy isn’t necessarily discredited elsewhere in the data. Even though the labour market has been resilient throughout the trade war, the December numbers were disappointing.
Trend employment growth in the service and construction sectors remains solid but job growth in the manufacturing sector has almost stagnated. Wage growth was also subdued with average hourly earnings printing a measly 0.1% compared to expectations of 0.3%.
While many analysts expect a revival of labour market strength and project the unemployment rate to dip below 3% by the end of the year, this does little to support inflation in the short-term.
This is likely to be the FOMCs primary concern, with core PCE cooling and inflation tracking below the 2.0% target for the lion’s share of this economic cycle.
December’s CPI report was another disappointing piece of data, with the headline rate printing at 0.2%, undershooting consensus estimates, while the core measure also undershot at just 0.1% growth.
While both annualised figures track at an elevated level of 2.3% respectively, it doesn’t necessarily translate to the Fed’s preferred PCE measure of price growth.
November saw both headline and core PCE measures print below target at 1.5% and 1.6% respectively. Base effects will be supportive for inflation readings in Q1 but anyone with a spreadsheet will see that.
Chart: The Feds inflation measures remain far from the 2% target
Prior to the blackout period starting, Fed officials were consistent in reiterating their patient stance on policy as they monitor the impact of last year’s 75 basis points of stimulus.
Q1 inflation data will need to be taken with a heap of salt due to the impact of base effects, while slowing growth continues to take some of the shine off labour market data. Current projections see both the labour market reaching inflationary levels of employment and output falling below the projected 1.9% estimated level of potential.
Market pricing deviates somewhat from the Feds official projections…
Overnight index swaps are pricing a full 25 basis point rate cut by the Fed by December’s meeting, whereas the December 2019 projections shows FOMC members expect rates to remain on hold throughout the year.
The development of data thus far does not suggest that any policy adjustments will be made in H1 2020 without a substantial change in conditions, but this will not translate to less attention on the Fed on the part of markets.
Inflation remains the greatest concern for the FOMC, and with the core inflation reading remaining subdued after accounting for base effects, inflation expectations may continue to track lower. This has led the bank to commit to a policy review, similar to the one launched by the ECB last week, with the results due in the first half of the year.
The inflation targeting framework and dot plot are likely to draw the most market attention and are highly subject to adjustment.
Recent member commentary suggests the Feds tolerance for inflation sitting above target has increased, with the threshold for rate hikes rising. A more symmetric inflation target, or even an average target, is likely, whereas the dot plot of member projections could be replaced by something less explicit.
Wednesday’s meeting will also draw questions about the longer-term solution to the pitfalls in the credit market under the floor system of monetary policy as the New York Fed continues to embark on open market operations.
Many expect the announcement of a standing repo facility, or variate thereof, when the framework review is released.
Author: Simon Harvey, FX Market Analyst at Monex Canada.