Fed meeting look-ahead

By David Morrison  |  31/07/2018 15:00

The US Federal Reserve is expected to keep rates unchanged. However, traders will be looking out for clues over the pace of tightening for the rest of the year

The Fed’s Federal Open Market Committee (FOMC) concludes its two-day meeting on Wednesday. This is predicted to be a bit of a ‘non-event’ with no change to the fed funds rate expected. This is hardly surprising, as while every meeting should be considered ‘live’ when it comes to rate hikes, the Fed usually saves any changes to the big quarterly meetings. This is when members of the FOMC also update their Summary of Economic Projections and when the Fed Chair holds a subsequent press conference. The last one was in June and this was when the Fed raised rates by 25 basis points as forecast. On top of this, Chairman Jerome Powell testified before Congress just last week stating that a continuation of gradual rate hikes should underpin the US’s ongoing economic expansion. There was nothing unexpected in anything he said to policymakers.

Despite this, investors will be keeping an eye on the FOMC statement for any additional insight into what Fed members are thinking about the pace of future tightening. The consensus view is that the US central bank will make two further 25 basis-point rate hikes before the year-end, with the market assigning a 90% probability to the first one coming in September. Consequently, any suggestion that the Fed is dialling back from this would be a surprise and should lead to a pull-back in the US dollar. But why would they? After all, the Unemployment Rate his hovering around 4.0% close to a seventeen-year low, while inflation, as measured by Core PCE, has hit the Fed’s 2% target. Considering Headline CPI (which includes volatile items like food and energy) it’s at 2.9%. On top of this, second quarter GDP came out at an annualised rate of +4.1% - well above the Euro zone’s +1.4% and the UK’s +1.2%. Now some analysts were expecting something hotter with Barclays predicting +5.2%, so in that respect it was a slight disappointment. On top of this there’s a view that the second quarter was boosted by companies stockpiling to get ahead of the threat of further tariffs on imports. Nevertheless, the US is outperforming just about everyone, unless one includes China where GDP is higher but decelerating.

But there’s another issue of which traders should be aware. The Fed is currently engaged in ‘quantitative tightening’ whereby it lets the bonds it purchased since the financial crisis mature without reinvesting the proceeds. In this way it is gradually reducing its balance sheet which had ballooned to around $4.5 trillion (from roughly $800 billion) since 2008. Even before the Fed began the process it was assumed that the central bank would look to get its balance sheet down to around $2-2.5 trillion. However, there have been hints that the Fed may now have a higher target of $3-3.5 trillion. Any allusion to this in Wednesday’s statement would be considered dovish and this could also lead to a weaker dollar.

Finally, analysts will also be looking out for any comments concerning the yield curve on US Treasuries. This has been flattening for months now (although it steepened a touch last week) with the 10-year/2-year trading below 30 basis points and the 30-year/10-year around 12 basis points. The concern is that, as the Fed raises at the short end, the yield curve will invert at some point, an event which frequently indicates that a recession may follow, often in less than a year.
In consequence, there’s plenty to analyse in tomorrow’s statement even without any chance of a rate hike. Most investors will be hoping that the Fed makes few changes from June, particularly given the recent hiccup in tech stocks and ongoing trade tariff concerns.
 
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