BNY Mellon: January FOMC Preview: Is Patience a Virtue

BNY Mellon: January FOMC Preview: Is Patience a Virtue

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By John Velis, FX and Macro Strategist, Americas, BNY Mellon

By John Velis, FX and Macro Strategist, Americas, BNY Mellon

Expect no change in rates from the FOMC on Wednesday. There will be plenty to discuss in Jay Powell’s post-meeting press conference. This will be the first time that the Chair will address reporters after an FOMC that does not include the publication of the quarterly Summary of Economic Projections. From now on the Chair will hold a Q&A after every FOMC meeting, representing yet another move towards a more communicative central bank. Those looking to for the Fed to a dovish turn will have to search for clues amongst the following issues.

FOMC Composition: We also not that the composition of the 2019 voting membership of the FOMC is marginally dovish with the ascension of St Louis’s Jim Bullard and Chicago’s Charles Evans (doves) offsetting Kansas City’s Esther George (hawk) and Boston’s Eric Rosengren (moderate).

State of the economy and balance of risks:  Expect the statement to pursue a middle course, with risks roughly balanced. It's probable that while still upbeat about the economy, the Committee will mention downside risks, in particular trade tensions, deceleration in other economies around the world, the effects of the shutdown (on which they will probably walk a very politically correct line), and possibly declining inflation expectations (5year breakevens have fallen by nearly 50pbs since the end of October.)

Path of rate hike hikes: Doves will be looking for the insertion of the word “patience” and softening of the language around the future path of rates. Last month they downshifted their rhetoric somewhat, saying that the committee “judges that some” further hikes are warranted (whereas earlier the phrasing had been that they “expect further” hikes”). Any additional softening around this will be seen as dovish.

Current 2y2y strips have dropped by nearly 70 bps since last autumn, and DEC19 OIS spreads imply just under one additional hike through the rest of this year as do year-end Federal Funds futures. It would take a lot of dovish spin to shift those expectations further.

Since the turn of the new year, a raft of Fed speakers have indicated that rate hikes are on pause as they examine the evolution of the economy and inflation. “Patience” has become the new watchword. In our opinion, expressed in December in our Global Annual Outlook, the Fed will continue to move towards dovishness as the year progresses, and there is good chance we’ll be debating the possibility of rate cuts by Q4 rather than hikes.

Balance Sheet: In our view it remains tall ask, but some in the markets are hoping for clarity on the final size of the balance sheet at the end of the Fed’s unwind. It’s unlikely this will be addressed in the formal statement but we expect Powell to be pressed on this in the Q&A. He may echo other recent Fed speakers, some of whom in recent weeks have hinted that the balance sheet could become a tool of monetary policy. If he says something on this, it’s likely to be interpreted as marginally dovish, indicating that the Fed would consider slowing the pace of withdrawal if conditions merit looser policy.

Data Dependence: Expect Powell to reiterate, in tandem with the message on patience, that the Fed remains data dependent (after all, that is the definition of patience in this context: one remains patient while awaiting more information). The problem is that owing to the shutdown, decent data have been hard to come by this month, providing yet another reason for the Fed to relent in offering too much precision on forward guidance. The data we have had has generally been weaker. For example the Consumer Sentiment Survey from the Conference Board on Tuesday registered a sharp drop, and the difference between current conditions and the forward looking expectations component is the largest since the beginning of 2001.

Figure 1: Consumer Sentiment, Current Situation vs Expectations

Summary: The market is probably lining up for a slight dovish tilt tomorrow, so USD downside risk is limited, unless the message from the press conference surprises even us. Nevertheless, to the degree to which the dollar’s strength is supported by the policy divergence trade, we view this leg of support will continue to wane as we move further into the year.

Figure 2: Policy tightening expected (defined as furthest OIS forward vs 2y2y forward strip) and DXY