Last month, the Federal Reserve made a major shift toward neutral policy, with 11 of the 17 FOMC members anticipating no further interest rate changes this year. Against that backdrop, this month’s meeting is more likely to provide an update to how the central bank is viewing the US economy, rather than any immediate changes to monetary policy.
Looking at the data the central bank prioritizes, the outlook for the US economy is muddled. Domestic growth remains relatively strong, as last week’s Q1 GDP report showed (though that strong growth was driven heavily by temporary inventory buildup and a potentially unsustainable rise in external trade figures). Despite the unemployment rate approaching a 50-year low, inflation data remains subdued, with Core PCE, the Fed’s preferred inflation measure, dropping in each of the last 3 releases to just 1.6% y/y.
As we highlight above, traders are now pricing in a potential interest rate cut from the central bank by the time we flip the calendars to 2020, something that exactly 0 of the 17 FOMC members anticipate. This will be the major dynamic to watch: Will the Fed’s statement hint at the potential for a rate cut this year, or will the central bank maintain its generally neutral outlook for another month?
The FOMC’s Vice Chairman, Richard Clarida, noted on CNBC earlier this month that there is precedent for such an “insurance cut”; in both 1995 and 1998, the central bank reduced interest rates even without signs of a recession looming. That said, we believe the Fed will take a wait-and-see approach for another month, leaving its outlook generally neutral until the next round of economic forecasts in June.
As a partial nod to the recent subdued inflation figures, we wouldn’t be surprised to see the Fed reduce its IOER (interest on excess reserves) rate by 5bps (0.05%) to 2.35%. This would have the effect of pulling the effective Fed Funds rate down marginally, though it would be more of a technical adjustment than anything.
The market’s confidence in a rate cut later this year has grown in recent weeks, so another neutral statement could prompt traders to pare those bets slightly. If the release plays out as outlined above, we could see continued strength in the US dollar and a possible headwind for US indices.
Signal2forex.com - Best Forex robots and signals
