FOMC Preview: Goldilocks Sets The Stage For Rate HIkes... Or Cuts

Tomorrow, at 2pm, the FOMC will leave its rates unchanged. As RanSquawk notes, the Fed will not publish new economic projections at this meeting (the next SEP is released in June), although the market will be closely watching whether the Fed outlines conditions that might compel the Committee to discuss lowering rates. There are some risks that the Fed might tweak its statement to reflect stronger growth and softer inflation since the last meeting, although the market has already priced in a "goldilocks" environment. There is also a small possibility the Fed could lower its IOER rate, which has been trading 4 basis points below the Effective Fed Funds rate and is in need of adjustment. Overall, the Committee’s tone is likely to remain one of patience and data dependence.

FEDERAL FUNDS RATE: Money markets have assigned a 97.5% probability that the FOMC will keep rates at 2.25-2.50% this week; there is no chance of a hike, and a very small (but not negligible) probability of a rate cut. Recently, remarks made my Charles Evans (voter, dove) have received attention, after he floated the possibility of cutting rates if inflation and inflation expectations decline further. Accordingly, Powell may be quizzed about the conditions the FOMC would need to see that would compel it to begin discussing rate cuts. Looking ahead, there is an approximately 60% chance of a rate cut this year, according to money markets pricing. Analysts at Citi stress that, as before, it does not think the Fed is planning to cut the FFR in the near-term, but instead, it is building optionality to cut rates should it need to in the future, and the hurdle for such cuts remains very low. “The Fed would mostly aim to ratify recent market pricing, but given the most recent moves there is also hawkish risk if Powell pushesaway the possibility of rate cuts this year.”

GROWTH: In its last statement (20 March) the FOMC stated that “growth of economic activity has slowed from its solid rate in the fourth quarter,” and that “recent indicators point to slower growth of household spending and business fixed investment in the first quarter.” But looking ahead, “the Committee continues to view sustained expansion of economic activity… as its most likely outcome.” Last week’s Q1 GDP report saw headline growth surprising to the upside at 3.2% Q/Q at a seasonally adjusted annualised rate (the Fed sees growth at 2.1% for 2019 as a whole), however, it was a result of large contributions from the inventory and trade components, which tend to be volatile; there is also an argument that the build-up of inventories could be seen as a negative. That said, Q1 data has historically tended to be underreported, Pantheon Macroeconomics points out (also noting recent research out of the Cleveland Fed, which suggests it is underreported by around 0.6ppts), and it would still be difficult to argue against the underlying economic momentum, at present, and there are some risks therefore that the FOMC might revise its language to reflect this. “The problem for the Fed,” Pantheon says, “is that if growth continues at anything like this pace, the labour market will tighten much further this year, and the question of rate hikes will be back on the agenda.”

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