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06 15 2016 | by Victor Xing | Central Banks

June FOMC: cautious policy amid macro uncertainty

June FOMC statement

The June FOMC surprised on the dovish side as policymakers reacted to the unexpected slowdown in the labor market, renewed weakness in market-based inflation compensations, as well as rising likelihood of a “Brexit” by revising down their SEP “dots.”  Some of these concerns were also reflected in the FOMC statement:

June FOMC statement: pace of improvement in the labor market has slowed, market-based inflation expectations declined

The Summary of Economic Projections (SEP) “dot plot” saw another downward shift.  Only one FOMC participant supported one hike in 2016 at the March FOMC, but that lone policymaker was joined by five additional colleagues at the latest meeting.  Based on individual FOMC participants’ policy stance, Chair Yellen is likely among these new one hike dots.

Market participants also debated the identity of the lone 0.63% dot for 2017 and 2018.  Some investors attributed it to Governor Brainard, but it is also likely to be Chicago Fed President Evans.  In a June 3 speech delivered hours before the dismal May Payrolls, President Evans suggested that the FOMC should keep rates on-hold until core inflation gets to 2% on a “sustainable basis.”  With the SEP projecting Core PCE to reach 2% by 2018, this view is consistent with the “anchored” 0.63% dot.

March FOMC SEP vs. June FOMC SEP: median funds rate estimate at 1.6% by end of 2017 vs. 1.9% in March; 2.4% by end of 2018 vs. 3% in March; longer-run funds rate estimate at 3% vs. 3.25% in March

FOMC press conference

At the FOMC press conference, Chair Yellen outlined several reasons to maintain a cautious policy path:

However, recent economic indicators have been mixed, suggesting that our cautious approach to adjusting monetary policy remains appropriate. As always, our policy is not on a preset course and if the economic outlook shifts, the appropriate path of policy will shift correspondingly.

  •  Recent pace of labor market growth have “slowed markedly”
    • Job gains in April and May have averaged about 80,000 per month
    • Labor market participation rate have declined
    • Broader unemployment rate, including part-time workers for economic reasons, has “flattened out”
    • Fed officials need to assure themselves that the underlying momentum in the economy has not diminished
    • Job gains in recent couple months have been “very low,” and “arguably not even at the pace needed to maintain stable labor market conditions”
  • Financial market-based measures of inflation compensation have declined
    • The FOMC will “carefully monitor actual and expected progress” toward its 2% objective
  • Caution is “all the more appropriate” from a risk management perspective; risks to inflation are asymmetrical with rates near zero lower bound
  • Brexit vote was one of the factors behind the latest Fed’s decision, and “it could have consequences” for “global economic and financial conditions” as international uncertainties “loom large”

Market reactions

Financial markets reacted swiftly to the changes in the SEP “dot plot” as the yield curve bull steepened to push 5s30s from 128 to 133 bps.  Rates subsequently bear steepened as long-end led the weakness, but renewed decline in risk sentiment managed to create a soft ceiling for bond yields, and the rates market rallied into the close.  Markets currently priced in below half of a hike for the remainder of 2016.

Rates ralllied into the European session close before weakening into the FOMC. 5s led the rally following the FOMC statement and SEP; source: Bloomberg L.P.

Dollar weakened following the FOMC to boost prices of gold, and the 5s30s curve maintained a steepening bias following the initial market reaction:

5s30s (gold) bull steepened as dollar (blue) fell

Next article06 08 2016 | by Victor Xing | Economics

April JOLTS: unexpected weakness in business services