As London draws to a close, the markets will likely remain volatile deep into the evening as investors brace for the conclusion of the FOMC meeting and Jay Powell’s press conference.
Later on, during the early hours of the Asian session, we will have New Zealand’s GDP estimate and Australia’s key employment data to look forward to. Then, the Bank of Japan will take centre stage, before the focus turns to the Bank of England later in the day on Thursday. But first, it is all about the Fed next. So, expect plenty of fireworks in FX, precious metals and indices.
How dovish will the Fed be?
The last FOMC meeting was on July 29, and since then the Fed and other central banks have become even more dovish as the pandemic continues to weigh on the global economic activity. But the promise of more stimulus has seen US equity indices hit new record highs despite increasing infection rates across the globe. The dollar has consequently fallen sharply, boosting the major currency pairs such as the EUR/USD and AUD/USD, as well as the appeal of precious metals, which continue to shine brightly. Investors have therefore been pricing in the prospects of low rates for even longer. Today we will find out whether their actions have been justified and exactly how dovish the Fed really is. The key focus will be on the new, more relaxed strategy on inflation. Powell and his colleagues will provide more details on this and discuss other measures to boost the economic recovery. The Fed is likely to suggest interest rates will remain at zero though 2023 and highlight potential risks to the economy that could arise from coronavirus and the upcoming US election.
Economic recovery has slowed
After the record 32.9% drop in growth in Q2 and the 5.0% slump in Q1, the economy has struggled to come out of the deep recession. Although things have improved sharply since March, the rebound as been from a low base and we’ve had a few signs of weakness in more up to date data. Thus, policymakers at the Federal Reserve will be extremely cautious with the choice of wording they will use in the policy statement in order not to give the wrong message.
On the plus side, employment has been rising and unemployment has fallen sharply compared to the height of the pandemic. The US unemployment rate was 11.1% in June, before falling to 10.2% in July, and then to 8.4% in August.
In so far as inflation is concerned, well the Fed now has a more relaxed approach towards price changes, as it now targets average inflation rather than a specific level. This means, any short-term rise in CPI should not materially change the Fed’s stance on monetary policy. In any case, there are no signs of strong price pressures yet with US CPI being +0.2% in June, +0.6% in July and +0.4% in August. The year-over-year rate of CPI inflation rose to 1.3% from a year ago after a 1% annual increase in July. Core CPI — which strips out volatile food and energy prices — reached its highest level since the pandemic at 1.7%.
US consumer spending has been increasing since June with spending going up +12.4% in May, albeit from a low base. The rebound continued in June as pent-up demand pushed spending up another +7.3% on the month. In July, spending rose modestly by +1.9% before falling 0.7% in August. So, consumer spending has slowed down since the Fed’s last meeting, which could be a cause for concern.
Meanwhile, some of the more forward-looking economic indicators since the Fed’s last meeting have generally improved, while some remain weak. For example, the ISM Manufacturing and Services PMIs have both improved markedly, although the latter dipped back a little to 56.9 in August.
So, to summarise, over the last three months, we’ve had more positive than negative news for the economy. The unemployment rate, for example, has fallen to 8.4% in August, while forward-looking manufacturing and services PMIs have continued to improve and point to confidence in the economy. Further, COVID cases which were at all-time highs in July are now much lower, hovering around 40,000 new daily cases. The death rates have fallen. Yet, a vaccine is yet to be approved, while cases have been on the rise again across Western Europe. In the US, it is expected that virus cases will increase as the colder months approach. Against this backdrop, the Fed will be cautious and likely provide a dovish outlook on the economy.