By Dean Popplewell
The Fed has a tough job; it must deliver the right message later this afternoon. U.S. policy makers cannot afford to convey any mixed signals; otherwise they will lose some of that hard earned “street cred” that Ms. Yellen and company have worked so carefully to obtain.
It’s probably safe to assume that many in capital markets have been eying the inconsistent U.S. economic data to date, and have concluded that the Fed’s caution means that they have already discounted any chance of an interest-rate increase at today’s FOMC meet.
Nonetheless, a U.S. economy portraying strong jobs and a comeback by the U.S. consumer with retail sales and other data are providing evidence that U.S. economic strength is on the rebound. But, and there is always one, wage growth and inflation remain relatively benign and corporations are worried about the “big” dollar's value on U.S. trade. Throw into the mix the IMF and World Bank advising the Fed to wait until early 2016 for a return to a more normal monetary policy and you have a scenario where the risks are too great for the Fed to be proactive at this time, or perhaps any time soon.
What Fed message can we expect?
Because a percentage of the market believes that we are nearly atop of the Fed’s first-rate hike (a September rate lift off is marginally ahead – 52% priced in), it’s vital that U.S. policy makers deliver the right message. Current price action would suggest that this market is unprepared if it’s too hawkish – the one directional move of the dollar over the past 14-months has already priced in rate normalization. Why? The dollar seems well contained across the board and is looking for ‘new’ reasons to climb.
The problem with a Fed message being too dovish is that it could worsen the markets complacency over the inevitable rate lift off, hence heightening market volatility even further. So investors should probably be expecting a more “guarded” statement with little to be given away during Ms. Yellen’s press conference. The Fed chair will probably make reference to an improving economy and subdued inflation.
With that in mind, expect the market to be focusing intently on the accompanying economic forecasts and “dot plot.” The last rate prediction was for two-rate hikes by year-end (+0.625%) and Fed funds at +1.875% by end of 2016. Currently, fixed income dealers are pricing in one +25bp hike by the end of Q4 and four-rate hikes next year.
However, nothing is a slam-dunk by Q4, but the Fed cannot afford for the market to become too complacent. This will require a gentle reminder from policy makers that they are still expected to move this year. The Fed wants a “gradual, painless tightening cycle,” but investors remain mixed over whether the Fed could or should increase interest rates. So it seems no matter what they deliver, market volatility will remain heightened.
BoE Hawkish statement supports cable
Tuesday’s U.K. CPI data was a bust for the pound hawk, however today’s BoE minutes; U.K. jobs data and earnings are a boon for the long sterling positions.
Cable has spiked half-a-cent to a fresh one-month high outright (£1.5740) after the U.K. ILO unemployment level came in at a seven-year low and average earnings rose +2.7% vs. +2.55% expected.
Earlier, the MPC minutes for the June meeting showed that all nine members voted to keep the Bank of England’s (BoE) benchmark interest rate at +0.5% and also voted unanimously to keep monthly QE at £375b.
Nevertheless, the minutes did have a “hawkish” tint with inflation expected to rise notably by late 2015. The two officials (Weale and McCafferty) who voted for a rate hike as early as last December again sit on the “finely balanced” fence. Fixed income dealers have brought forward the first BoE rate hike by two-months and are pricing in a rate lift off for the end of Q2, 2016.