US-China trade is likely to remain the elephant in the room for the Fed and monetary policy globally.
The fractious state of domestic politics in the US, and a need to protect the independence of the Fed, means that Jerome Powell can hardly say that the Fed will cut further only if the trade war continues to hobble the US and global economy.
Instead, the FOMC will be forced to make this point implicitly by emphasizing a data dependent stance at Wednesday’s meeting in addition to cutting rates.
The FOMC will almost certainly cut the Federal Funds rate by 25 basis points this Wednesday, but with markets pricing in a deeper pricing cycle than suggested by recent Fed communications, next week’s meeting is something of a last chance for the Fed to signal some caution around further cuts.
If we do see a pushback on the idea of further easing, perhaps in the form of a relatively upbeat assessment of the medium term inflation outlook, the dollar may regain a bit of the momentum that it seems to have lost so far in the fourth quarter.
Recent official FOMC statements and minutes make it clear that a majority of the Committee still does not believe a deep cutting cycle will be necessary in the next year.
Further cuts of the scale expected by fixed income markets seem to be reserved for an economic downturn of a sort that is not currently evident in the data, but is plausible should US-China trade tensions worsen. Even the most bearish member projections of the policy rate show the Fed’s cutting cycle bottoming out with one more 25 basis point cut.
Market expectations remain far more bearish, with OIS and Federal Funds futures suggesting that participants are expecting around three more cuts over the next year.
Given the Fed has previously shied away from inadvertently tightening financial conditions by not delivering on rate cuts that are already priced in by fixed income markets, this week’s meeting offers an important opportunity to push back against expectations for more easing.
Looking beyond the FOMC…
The US data calendar offers major events in the form of a first look at Gross Domestic Product in the third quarter and monthly jobs figures.
The very poor state of survey data in Q3 will hang over Tuesday’s release. ISM Manufacturing PMI, for example, is at its lowest reading since 2009, with the services sub index also showing signs of a slowdown.
Manufacturing is a relatively small 11% of US GDP, and other manufacturing surveys are not quite as grim. However, manufacturing is a fairly reliable cyclical indicator, and the occasions in recent history (Q4 2015, H2 2012) where the ISM index has been comparably low were accompanied by significant slowdowns in quarterly GDP.
This week’s GDP release therefore probably has at least some downside risk attached to the median forecast for around 1.6% annualised growth.
Non-Farm Payrolls will be worth watching for similar reasons, such as the decline in reported payroll growth in many surveys in Q3 and the decline in actual headline job creation in recent months.
Author: Ranko Berich, Head of Market Analysis at Monex Europe.