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FOMC Preview: Fed to Maintain Dovish Tone and Announce Plan to End Balance Sheet Reduction

At the upcoming FOMC meeting, the members would vote to leave the Fed funds rate target at 2.25-2.5%. We expect reinforcement of the dovish message conveyed in January. The focus is on the plan to complete the reduction of its balance sheet, which peaked at US$ 4.5 trillion in 2015. Besides, the Fed would release its quarterly median dot plot and updated economic projections.

Economy Slowed Further since January Meeting

Economic developments since the January meeting have continued to slow, in line with the Fed’s dovish stance. GDP growth decelerated to an annualized +2.6% q/q in 4Q18. The slowdown was, however, less than expected, as supported by business investment. The latest data on the job market was disappointing. Non-farm payrolls increased +20K in February, sharply lower than consensus of +180K and January’s addition of +311K. The unemployment rate slipped to 3.8%. On inflation, headline CPI reached 2.5-year low of +1.5% y/y in February. Yet, core CPI, at +2.08%, stayed around the Fed’s target. The Fed’s preferred measures of inflation, core PCE, climbed higher to +1.94% y/y in December 2018.

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End of Balance Sheet Reduction 

Recall that the Fed noted in the January statement that it is “prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments”. The dovish tone was reinforced in the minutes, which revealed that “almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year”. It is likely that the Fed would announce the plan to end balance sheet reduction next week.

Forward Guidance and Median Dot Plot

In January, the Fed called for “patience” in deciding “future adjustments” to the policy rate. We expect it to reinstate this stance in March. As an indicator of the Fed’s interest rate path, the median dot plot is closely-watched. After trimming the number of rate hikes in 2019 to two times (from three times in September) in December, the market is expecting the members to rule out any rate hike this year. In a speech late Friday in Stanford, California, Fed Chair Jerome Powell suggested that there would be a review on the role dot plot. As he noted, “returning to a world of little or no explicit forward guidance in the FOMC’s post-meeting statement presents a challenge, for the dot plot has, on occasion, been a source of confusion”. Yet, he added that there would not be changes in the 2% inflation target.

Economic Projections

Given the moderation in both the global and domestic growth outlook, the Fed would revise lower its GDP growth and inflation projections. However, we expect the downgrades would be less significant than those by ECB. After all, US growth has stay about trend.

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