28.10 Weekly Viewpoint : The November FOMC meeting should leave monetary policy unchanged

At its November meeting, the FOMC is likely to play for time, keeping monetary policy unchanged and paving the way for a hike in December. The vote should again be not unanimous, with at least two dissents…..

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The statement should indicate that the Fed’s two goals are “very close”. The assessment of the economy is expected to remain positive, and to outline on-going growth at a moderate pace, a further improvement of the labour market, and a gradual rise in inflation towards 2%. Risks to the scenario should remain “roughly balanced”.

After the expected hike in December, the FOMC will again face the problem of building internal consensus on the interest rate path, and to communicate it to the market as clearly as possible. In 2017 this task will be even more difficult than in 2016.    

The November FOMC meeting should leave monetary policy unchanged and signal that a federal funds rate hike will come soon. There should be at least two dissents (George and Mester), while Rosengren may join the majority in this pre-electoral meeting.

The assessment of the economic picture should stay positive, and confirm that “the case for an increase in the federal funds rate has strengthened”. Since September, the FOMC has received solid information from the labour market, with non-farm payrolls growth at around 160k, higher than the average change in the labour force, estimated by the San Francisco Fed at between 60k and 110k. The increase in the unemployment rate to 5% is due to a recovery in participation (labour force up sharply for four consecutive months), and is a positive signal of falling slack. Lastly, the wage trend, while slow, is still positive, and meeting the demand for skilled labour is increasingly difficult. The labour market is now at or very close to, full employment. With respect to growth, H2GDP indicators are in line with the expected reacceleration, with a solid consumption trend and improving investments. The outlook for Q4 points to moderate growth, above the potential rate (now estimated at 1.8%), driven by consumption, but also accompanied by a modest improvement in manufacturing, based on orders, sector surveys, and the reduction of political uncertainty after the elections. Lastly, with respect to core inflation, the gradual uptrend scenario has played out in the past months. The statement may report a recovery in market based inflation expectations, up since June; however, inflation expectations based on survey data are still at their long-term lows.        

In terms of financial conditions, the recent corrections of the markets have been contained. Credit is on a sustained uptrend, showing double-digit growth in lending to the commercial construction sector. The only modestly negative development is the appreciation of the effective exchange rate of the dollar, (+0.8% since 21/09, but -0.4% since the beginning of 2016). Economic conditions at the glob level are moderately favourable, although foreign trade remains generally weak. The surge in US exports in 3Q is a temporary development; however, a slowdown in foreign sales in the closing months of the year non should significantly alter the overall growth trend.

In conclusion, the picture is compatible with indications that a rate hike in on its way, based on the conditions the FOMC seems to be requiring to gradually remove monetary stimulus. The September statement said that the case for an increase had “strengthened”, but the Committee had decided “for the time being, to wait for further evidence of continued progress toward its objectives”. Data have provided such “further evidence”, and in November the FOMC will have some trouble justifying a decision to keep rates on hold once again, without mentioning the real reason, i.e. the elections on 8 November. Communication is not the FOMC’s forte at the moment: information on what kind of progress, and of what size, still needs to come to prompt a rate increase is nowhere to be found. The statement will attempt to provide convincing indications to the market, which in any case is already pricing in a very high probability of a move in December. However, the problem will show up once again in 2017, with a newly cloudy path for the subsequent hikes, also due to the difficulty in building consensus within the Committee. 

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