The Market Today
FOMC Decision – Unlikely to Completely Reverse Course
by Craig Dismuke, Dudley Carter
FOMC Decision – Unlikely to Completely Reverse Course: The FOMC concludes its two-day meeting today and is expected to deliver another dovish result, perhaps completing a total reversal from the policy stance in September, as we discussed on Fox Business this morning. If so, the markets are likely to interpret the change as evidence that the “Fed put” remains alive. As recently as the Fed’s September Summary of Economic Projections (SEP), they were projecting three rate hikes in 2019 followed by another in 2020. As recently as December, the balance sheet was expected to continue rolling off, uneventfully in the background, at a $50 billion-per-month pace. After today’s decision, it is possible that all three hikes projected for 2019 will be removed from the median forecast and the balance sheet roll-off will be scheduled to conclude before year-end. Our basecase expectation is that the median dot will continue to show one hike in either 2019 or 2020, stopping short of being a complete reversal of policy.
Target Rate: There is no expectation for a rate hike, nor a rate cut, at today’s meeting.
Balance Sheet Roll-Off: Expectations are that the balance sheet will continue to roll-off at a $50 billon-per-month pace. However, the Fed is likely to announce a plan soon, as early as today, for the cessation of the roll-off. Based on recent Fed communications, it appears they want to keep the balance sheet near $3.0 to $3.5 trillion to maintain ample liquidity in the system. If correct, they are likely to announce a 3Q19 or 4Q19 conclusion.
Economic Assessment: The economic assessment is likely to be less rosy than it has been. It will be more difficult to say that household spending is “growing strongly” after the worst December for retail sales in 20 years. The assessment of inflation may also create some headlines given that inflation is expected to run weaker-than-target in the near-term and inflation expectations have declined.
Summary of Economic Projections: The key to the report is likely to be found in the SEP. While the 2019 growth and inflation forecasts are likely to be notched slightly lower, the more meaningful projections will be those for interest rates. It is expected that the median forecast will reflect, at most, one hike in 2019, down from two in the December SEP. If the median forecast still calls for one hike in 2019, policy could be characterized as “patient” with an expectation that growth will continue at an above-sustainable rate. There is also speculation that the median dot may drop enough to show no hikes in 2019. If so, this would reflect a complete turnaround for policy from September. This outcome is the most likely factor dictating investors’ and analysts’ perception of today’s decision.
Inflation Target: The Fed is in discussions to change its inflation-targeting scheme after investors and consumers have become convinced that future inflation will be too contained. While a decision is unlikely until after the Fed’s June policy framework meeting, any insight gleaned from Fed Chair Powell’s press conference could be material to the markets. At issue, Fed officials are trying to increase inflation expectations, enabling yields to rise more than they have during this rate cycle. In order to accomplish this, they are now considering moving from a static 2% target to a 2% average target. In the current scheme, if the economy misses this part of the Fed’s dual mandate, there is no make-up period. If inflation were to run at 1% for two years then jump to 2%, the Fed’s goal would be achieved. Under the most likely scheme to be adopted, inflation averaging, the Fed would keep policy accommodative enough to allow inflation to run above 2% for a sufficient period of time so that inflation averaged 2% over the cycle. While such a decision may solve today’s dilemma, it would create a future challenge: Would the Fed be willing to cut off economic growth sufficiently to push inflation down to just 1% if it had previously been running at 3%? If so, this would heighten the risk of an even more significant policy mistake at peak growth. Moreover, it could create more volatile swings during economic cycles. Nonetheless, any evidence of progress in moving to inflation averaging would imply a more dovish Fed in the near-term.
Mortgage Applications Rise but Remain Depressed: Released this morning, mortgage applications for the week ending March 15 rose 1.6% on a 0.3% increase in purchase apps and 3.5% increase in refi apps. Refi apps have actually increased over the past month, the most convincing uptick since September 2017, as mortgage rates have dropped. Purchase apps remain weak, but have shown a little life rising 4% over the last few weeks.
Yesterday – Positive News on Brexit Gives Way to Snag in U.S.-China Trade Negotiations: Treasurys opened Tuesday with the 10-year yield up 4 bps and the 2-year yield up 2 bps. The rise in yields accompanied an increase in German Bund yields, which were pushed higher by news reports that the U.K. would seek a 9- to 12-month Brexit delay from EU officials. Other news reports said that EU officials would not finalize a Brexit extension at this week’s Global Solutions Summit. Also pushing Treasury yields up early in the day was a large trade of 10-year futures contracts. However, reports that U.S. – China trade negotiations hit a snag pushed yields lower by midday. According to reports, Chinese officials were concerned that the Trump administration had not agreed to lift its already-imposed tariffs and backed off agreements on intellectual property protection and data protection for pharmaceuticals. Along with news last week that the Trump-Xi meeting would not take place until April or May, the snag weighed on risk assets. The 10-year yield pulled back from 2.63% to 2.60% (closed at 2.61%) and the S&P swung from +0.7% to -0.2% for the day.
Overnight Trading – Calm Before the FOMC: Markets were generally quiet overnight as investors await today’s FOMC policy decision. Inflation in the U.K. unexpectedly ticked up from 1.8% to 1.9% in February on higher food and video game prices, but remained below the BOE’s 2.0% target. In Japan, Prime Minister Abe told parliament that he believe the BoJ’s 2% inflation target was beneficial and that he had confidence in BoJ Governor Kuroda’s ability to achieve the target. After years of missing the inflation target to the low side, there have been calls for the BoJ to adopt a target inflation range or lower the target. The Japanese government, concerned about the impact of an October sales-tax hike, cut its economic growth forecast. Despite the gloom, Japan’s Nikkei 225 was one of the few stock markets in the black overnight, up just 0.2%. Eurozone stocks are down 0.6% while U.S. stock futures are slightly positive heading into the U.S. trading day. Treasury yields are down 2 bps overnight, with the 10-year yield coming into the day at 2.59% and the 2-year yield down to 2.45%.
Factory Orders Report Shows Weak Consumer Goods Orders But Confirms Stronger Business Activity: The Census Bureau reported that new orders for manufactured goods rose 0.1% in December, weaker than the expected 0.3% gain. Orders for consumer goods were weak, down 0.5% MoM and 3.8% over the past three months. Unfilled order for consumer goods also fell, the sixth consecutive month showing fewer unfilled orders. On a positive note, the final revision confirmed the unexpectedly strong 0.8% MoM increase in core capital goods orders, an indicator of future business investment in equipment, despite the weaker ISM Manufacturing Index for February. Moreover, the report also confirmed the 0.8% MoM increase in core capital goods shipments, a measure of business investment used in the calculation of GDP. The January data paints a less encouraging outlook for the consumer; but, the rebound in capital goods orders and shipments provides optimism that businesses are continuing to make capital investments despite all of the trade uncertainty.