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FOMC: All eyes on the US central bank this week - BBH

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Mar 14, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

    Oct 7, 2015
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    Research Team at BBH, suggests that this week the Federal Reserve meets and will update its forecasts and Yellen will hold a press conference.

    Key Quotes

    “At the end of last year, the Fed seemed to have suggested the likelihood of a March hike. In fact, the economy has played out broadly consistent with what it had anticipated. The slowdown in Q4 was temporary, and the economy would return to trend or higher growth.

    As long as the labor market continued to absorb slack, which it has, officials could be reasonably confident that core PCE would move toward the Fed's target, which it has. Inflation expectations, as measured by the 10-year breakeven, have recovered from 1.11% in mid-February to 1.55%, which is higher than when the FOMC hiked rates in December.

    Another constraint on Fed policy that got a lot of airplay was the strength of the dollar. Since the end of January, a trade-weighted measure of the dollar has fallen by 4.6%. It has returned to levels seen last October.

    The same logic that led the Fed to unanimously hike rates in December (and anticipate that four hikes this year would be appropriate) suggests a March rate hike. However, Fed comments and concern perhaps about lending conditions following the tightening suggested by the senior loan officers’ survey have suggested a hike is unlikely. The March Fed funds futures contract, for example, is pricing in practically no chance of a hike this week.

    When in doubt, the Fed has erred on the side of caution. First with the tapering and then with the first hike. What argues against an April hike is the lack of a press conference. Yellen has indicated that all meeting are live, and policy action can be taken without a press conference.

    Nevertheless, given importance of communication, underscored by Draghi's press conference, the Federal Reserve is likely to still want to explain itself. As we have argued before, a press conference after every meeting, as many other central banks do (including the ECB and BOJ) would actually create more options for the Fed.

    The pendulum of market expectations are swing away from the idea that the December rate hike was one and done for the Fed. If we assume that the effective Fed funds rate averages 37 bp for the first 15 days in June and that the Fed hikes the range 25 bp, and Fed funds average 62 bp in the second half of the month, then fair value is 50 bp. Before the weekend, the June contract closed with an implied yield 47.5 bp.

    If the Fed does not hike rates this week, it will likely keep the market anticipating the likelihood of a hike in Q2. There are two ways that the Fed may communicate this. First, it may acknowledge that risks are nearly balanced. Remember in January, the Fed refused to update is risk assessment. Second, the Fed's dot plots could be consistent with three rate hikes instead of four this year. That would simply be an acknowledgment that it was not hiking rates in Q1, but that its underlying assessment had not significantly changed.”
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