05.05 Weekly Viewpoint : The FOMC stays on course

The FOMC stays on course: slowdown in 1Q “likely to be transitory” and does not change the expected path of gradual interest rates hikes. The string of speeches and the minutes should confirm expectations for another two rate increases in 2017, and for the normalisation of balance sheet policy to start by the end of the year……..

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As expected, the FOMC meeting left rates unchanged and confirmed a positive assessment of the economic outlook, with a unanimous vote. Lacking fresh information, the positive tone of the statement with respect to the evolution of the economic picture points to confirmation of the gradual hiking cycle envisaged by the Committee for the rest of the year. However, the statement noted that “the labour market has continued to strengthen even as growth in economic activity slowed”, with job gains that were “solid, on average, in recent months”, and a decline of the unemployment rate. Most importantly, household spending rose “only modestly, but the fundamentals underpinning the continued growth of consumption remained solid”: this clears fears of a sharper slowdown in household spending than seen at the beginning of the year. The statement acknowledged the drop in core inflation in March, but refrained from commenting. The view on the outlook is clear: “the Committee views slowing growth during the first quarter as likely to be transitory” and continues to expect moderate growth and a return of inflation towards 2%, with “roughly balanced” risks. Thus, weak growth and inflation data at year start, have not changed expectations for a gradual rate hike path, as always dependent on the evolution of data and of domestic and international financial conditions. No changes in wording were introduced on the topic of balance sheet policy, and the current repurchase policy is expected to remain in place “until normalisation of the federal funds rate is well under way”. The usual busy agenda of post-meeting speeches begins today: 15 in a week (including Chair Yellen and Vice Chairman Fischer) must mean something! The speeches, as also the minutes due out on 24 May, should shed light on the evolution of the debate on repurchases, and signal that the Committee’s baseline scenario continues to contemplate two further hikes in 2017, considering that May meeting brought no changes in tone, nor alterations of the macroeconomic assessment. Therefore, expectations for a move in June remain valid.

In Europe, the week’s economic data, and developments on the political front, could make the ECB’s assessment of the economic picture a little brighter at the next Governing Council meeting in June. The latest round of PMI releases, referred to April, places the services index at high levels, close to those hit in March, whereas the manufacturing PMI rose further. These indications are compatible with the equally positive ones already yielded by the European Commission’s quarterly survey, and add themselves to a picture which had already seen the real economy grow, and stabilise in the opening quarter of the year at 0.5% q/q (1.7% y/y). Although the global PMI was weaker in April than in March, the trend of foreign demand remains favourable.

Furthermore, on the political front, in the closing days of the presidential election campaign in France, Macron’s position has strengthened in the voting intention polls, which now award him a 20-point lead over Le Pen, and therefore a very high probability of winning. If Sunday’s vote confirms the aversion of the terrible risks the victory of the eurosceptic candidate in France would have implied, the ECB will have greater freedom of action. Yesterday, Praet acknowledged that risks to the recovery are roughly balanced, and explained that the central bank is waiting for further evidence from data, and that the information set could be more exhaustive in June. Praet also pointed out the wage trend as crucial for the trend of underlying inflation. A marginal degree of restriction has already materialised as a result of market movements: an appreciation of the exchange rate, and a (modest) increase in medium and long term rates on the core markets (excluding France, of course). However, these movements have been offset by the trend of equity indices and by the reduction of credit risk premiums.

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