Thoughts on the FOMC’s Statement

As expected, the Federal Open Market Committee’s (FOMC) April statement on monetary policy did not signal a dramatic change from that of March. There will be no press conference this month. Minutes will be released in two weeks. The statement was effectively a mark-to-market based on the recent evolution of data.

The Committee remains cautious regarding economic growth. The committee downgraded its assessment of recent activity but attributed the weakness partly to temporary factors.

The Committee’s statement:

Retained language referring to a softer economic backdrop – “economic growth slowed during the winter months”.

• Since the last meeting, the data continues to be relatively weak. Specifically, the March Nonfarm Payroll number was below expectations, and the February number was revised downward. While average hourly earnings were up, hours worked went down. On the economic front, retail sales and capital expenditures have both been weaker than expected, although retail sales have improved. The weak trend was reflected in the soft 1st quarter GDP report (0.2% QoQ annualized rate) released today.

Recognized that inflation appears to have stabilized at low levels – “Inflation has continued to run below the Committee’s longer-run objective”, which is an update from “declined further.”

• Since the March meeting, the price of oil has stabilized, as has the dollar. Realized inflation has stabilized and, in many cases (core CPI, core PCE, and headline PCE), is accelerating.

The committee did not change their forward looking outlook.

• In fact the FOMC signaled they are looking past Q1, “Although growth in output and employment slowed during the first quarter, the Committee continues to expect that, ….economic activity will move……toward levels the Committee judges consistent with its dual mandate.”

Reiterated its view that below-normal rates may be needed for some time.

Reiterated that the timing of the initial hike remains data-dependent.

Over the near term, we expect:

Consistent with the Fed’s guidance, we expect two rate hikes in 2015 – in September and December – with a year end fed funds rate of 0.75% (the top end of the range, which is currently 25bps).  We expect an additional four rate hikes in 2016 to 1.75% by year end.

Today’s actions will likely have limited impact on yields as the statement reinforces a data-dependent policy path. The significant accommodation and gradual normalization process reiterated by today’s statement is supportive of yields and will minimize the risk of a large and disruptive sell-off in the market.

Continued moderate volatility

Over the medium/longer term, we expect:

Increased volatility as the market adjusts away from forward rate guidance, but that volatility will eventually be dampened by liquidity from central banks

A higher probability for trend or above trend growth to be supportive of risk assets

Growth and higher rates in the U.S. should contribute to a stronger dollar

The front end of the yield curve will be repriced to higher rates as we approach the initial rate hike. Meanwhile, technical support for the long end of the curve will continue, resulting in a bear flattener (long term rates move up, but short term rates move up more).

While stronger data suggests that rates should move modestly higher across the curve, as reflected in the table below, the move to higher rates could be tempered by the extreme shortage of duration in Europe that continues to compress global yields.