The Daily Update - Deteriorating US data and the Fed

With a holiday filled week ahead, it seems the most exciting bit of news this week will be from the Federal Reserve meeting which ends tomorrow. Although nothing is expected to change in terms of rates, with the futures market currently pricing in less than a 15% chance of a hike, it will be interesting to hear what the committee says in terms of future guidance; especially following a particularly weak set of data releases.

US economic data points including personal income and personal spending and the Fed’s favored inflation reading, the PCE core were released below expectations; PCE was 1.6%yoy in March, from 2.1%yoy in Feb and well below the 2% target. In fact serial ‘no’ rate hike voter Neel Kashkari, Minneapolis Fed president said ‘For the last five or six years, the Federal Reserve keeps predicting inflation is around the corner. And those predictions end up being wrong.’ Meanwhile the annualised GDP release for Q1 also missed expectations, released at 0.7%qoq, where the prior reading was as high as 2.1%. The more recent ISM manufacturing reading for April also disappointed, falling to 54.8, although still in expansionary territory but down from March and well below market calls for 56.5. The new orders and employment sub-indexes were the main drivers of the decline in March’s readings, however also remaining within reasonably attractive expansionary levels.

Following the deterioration in economic data readings, although the probability of a rate hike is currently priced in at over 71% in June, we suspect the FOMC statement tomorrow will not explicitly indicate a move to hike next month. We do not expect any material updates in regards to how the Fed wishes to shrink the balance sheet either. Former Fed Chair, Ben Bernanke did however say he expects the central bank could reduce its USD4.5tn debt by as much as half, stating yesterday, ‘I think they’re aiming for something in the vicinity of $2.3 to $2.7 trillion’. Bernanke did however add that he doubts the $1tn pre-financial crisis levels will be achieved any time soon.

There is nothing in the recent data releases to suggest that the US economy is in any way materially better off than in was a year ago, however it seems to us that the Fed wish to remain ahead of the curve and aim to get to a stage of normalisation, where they will have increased flexibility to reduce rates during the next economic downturn; which may not be too far off. However Treasury Secretary Steven Mnuchin yesterday said that the US could potentially get to a stage of 3% growth in two years through tax reform, regulatory relief and fairer trade policies. Meanwhile Bernanke suggested growth in the US could not exceed 3%.

We look to key economic data releases later this week, including employment figures, where the market is currently looking for +190k jobs, and an increase in unemployment to 4.6%.