Investment Research General Market Conditions FOMC Preview · 2015-10-26 · Important disclosures and certifications are contained from page 8 of this report. Investment Research

Important disclosures and certifications are contained from page 8 of this report. www.danskeresearch.com

Investment Research — General Market Conditions

The FOMC meeting this week is unlikely to provide us with much new

information. We expect to receive a statement but no updated projections or

press conference. Along with consensus, we expect no change in policy at the

meeting.

We believe the Fed wants to keep all doors open at this point and will try to

signal that a December rate hike is an option but by no means given. If markets

keep still after the statement, we think the Fed can declare its mission

accomplished.

The tone on recent economic developments is likely to be more downbeat than in

September but global economic and financial developments should have become

less of a risk.

In our view, the forward-looking part of the statement is likely to be kept

broadly unchanged, as the Fed awaits more data before changing its view on the

outlook.

All doors likely to be kept open

Recent Fed comments have underlined the divergence in views on monetary policy within

the FOMC. In particular, the two board members Lael Brainard and Daniel Tarullo

delivered dovish comments in their speeches two weeks ago, suggesting they did not see

a rate hike coming before next year. On the other hand, vice Chair Stanley Fischer and

Janet Yellen herself reiterated this month that they think a rate hike later this year is

appropriate contingent on economic developments. On top of this, the minutes from the

Board of Governors’ discount rate meetings revealed that eight out of the 121 regional

Fed banks advocated an increase in the discount rate at the September FOMC meeting – a

signal that they would favour an increase in the fed funds rate as well. However, this

request was not met by the Fed Board.

This shows the current divergence within the FOMC and we believe that more data is

needed before consensus can move in either direction. Thus, we do not expect any change

in policy and the intention for the October FOMC statement is in our view to keep the

door open for a December rate hike but to signal that it is by no means a done deal. We

think this is best done by making only minor changes to the forward-looking part of the

statement. We expect Jeffrey Lacker to dissent again this week and advocate a rate hike.

The key phrases to watch are, first, the description of ‘global economic and financial

developments’, which in September were described as something that might restrain

economic activity.

1 The Federal Reserve banks of Philadelphia, St Louis, Cleveland, Richmond, Atlanta, Kansas City, Dallas and San Francisco voted for a 25bp increase in the discount rate, while Minneapolis voted for a 25bp decrease and Boston, New York and Chicago voted for an unchanged rate. See the hawk-dove overview below.

26 October 2015

Senior Analyst Signe Roed-Frederiksen +45 45128229 [email protected]

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Still waiting for the green light

mailto:[email protected]

2 | 26 October 2015 www.danskeresearch.com

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Given the recent improvement in these, including the risk rally following the ECB’s pre-

announcement of further easing at the December meeting, this phrase is likely to be

changed in a more positive direction. Second, is that ‘some further improvement in the

labour market’ and ‘reasonable confidence that inflation will move back towards 2% over

the medium term’ still what is needed for the Fed to increase rates? We think so but any

changes to this sentence will be crucial for the market’s interpretation of the statement.

How the Fed chooses to describe the latest economic developments, in particular the

labour market will also be important. Given the recent slowdown in job growth and

continued lack of rising wage inflation, the wording on the labour market in the first

paragraph of the statement is likely to be somewhat more downbeat than in September.

On the other hand, the overall description of economic activity is likely to stay unchanged

i.e. ‘expanding at a moderate pace’.

Market implications

The Fed is likely to deem its communication at the October meeting a success if markets

stay broadly unchanged following the release. Whether it will succeed in this is up to the

exact wording in the statement. Currently, markets attach a 36% probability of a

December rate hike and a 75% probability of a March rate hike. In our view, this is fair as

the current mix of economic data does not send convincing signals about the economic

outlook. A more downbeat description of the labour market could push the pricing of fed

rate hikes in a slightly more dovish direction but the move is likely to be fairly muted,

particularly if the FOMC changes itsr tone on global risks in a less worried direction.

Outlook

We continue to believe that the first fed funds rate hike will come at either the January or

March FOMC meeting next year, with the highest odds on a January move. The

combined soft tone from the ECB on Thursday (see Flash Comment: ECB to cut the

deposit rate further, 22 October), followed by easing from the Chinese central bank on

Friday and possible policy easing from the Bank of Japan and Swedish Riksbank this

week, means the trade weighted US dollar has gained 2% over the past one and a half

weeks. While on the margin this has tightened financial conditions, the rally in risky

assets has largely offset this move. What is left is the positive demand boost from easier

monetary policy and diminishing risks of an even more severe global growth slowdown.

Hence, we believe that this latest round of policy easing is welcomed by the FOMC.

http://danskeanalyse.danskebank.dk/abo/FlashCommentECB221015/$file/FlashComment_ECB_221015.pdf

http://danskeanalyse.danskebank.dk/abo/FlashCommentECB221015/$file/FlashComment_ECB_221015.pdf


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FOMC hawk-ometer

Hawk-dove overview

Source: Federal Reserve, Danske Bank Markets

2014 2015 2016

HAWKISH Plosser Harker Harker Philadelphia

R.Fisher Kaplan Kaplan Dallas

George George George Kansas city

Lacker Lacker Lacker Richmond

Mester Mester Mester Cleveland

Bullard Bullard Bullard St. Louis

Lockhart Lockhart Lockhart Atlanta

Vacant* Landon Landon Board

NEUTRAL Vacant* Vacant* Vacant* Board

Williams Williams Williams San Francisco

Powell (B) Powell (B) Powell (B) Board

S. Fischer (B) S. Fischer (B) S. Fischer (B) Board

Tarullo (B) Tarullo (B) Tarullo (B) Board

Yellen (B) Yellen (B) Yellen (B) Chairman

Brainard (B) Brainard (B) Brainard (B) Board

Dudley Dudley Dudley New York, Vice Chairman

Evans Evans Evans Chicago

Rosengren Rosengren Rosengren Boston

Kocherlakota Kocherlakota ? Minneapolis

DOVISH

Bold signifies voting right (B) Signifies Board member


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FOMC chart book

Continued solid labour market progress – stronger than June 2004 (start of previous hiking cycle) on most measures

Note: The diagram shows the level of tightness of different US labour market key figures at different times, compared with the level of the same figures in June 2004

(index=100). Counter cyclical figures (unemployment rate, jobless claims, marginally attached and work part time for economic reasons) are inverted; thus, the higher

index (the further from the middle) the better (tighter) is the state of the labour market

JOLTS data for December is an average of October and November data.

Source: BLS (JOLTS), Macrobond Financial

Fed funds rate expectations fell after September FOMC

meeting and the payrolls report

Effective USD has strengthened over past two weeks

Note: Dark (light) shading indicates periods of tightening (easing)

Source: Federal Reserve, Danske Bank Markets

Source: Federal Reserve, Bloomberg, Danske Bank Markets

Payroll employment

Job openings

Hires

Hiring plans

Job availability

Quits

UnemploymentMarginally attached

Part time for economic reason

Job f inding

Initial claims

Unable to f ill job openings

Temporary help services employment

June 2004 September 2015

Leading indicatorsEmployer behavior

Utilization (slack)

Confidence


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Core inflation is running below Fed’s comfort zone... ...and no clear trend


Source: BEA, Danske Bank Markets

Source: BEA, Danske Bank Markets

High unit labour costs are producing some inflation pressure Inflation expectations have fallen


Source: Federal Reserve of Philadelphia, Macrobond Financial, University of

Michigan, Danske Bank Markets

Source: Federal Reserve of Philadelphia, Macrobond Financial, University of

Michigan, Danske Bank Markets

Job growth has slowed in past two months Unemployment rate continues to drift lower


Source: BLS, Danske Bank Markets




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Unemployment gap (actual – NAIRU) has closed... ...but wage inflation remains subdued


Source: BLS, CBO, Danske Bank Markets



Divergence between manufacturing and service sector Consumer confidence has come off the highs but stays solid


Source: ISM, Danske Bank Markets


Source: University of Michigan, Conference Board, Danske Markets

Personal spending has shown strong growth... ...supported by healthy real income gains


Source: BEA, Federal Reserve of St Louis, Danske Bank Markets

Source: BEA, Federal Reserve of St Louis, Danske Bank Markets


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House prices moving higher and sales pace have picked up Corporate funding costs have risen on wider credit spread

Source: NAR, U.S. Census Bureau, Danske Bank Markets Source: Moody’s, MBA, Federal Reserve, Eurostat, Danske Bank Markets


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Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske

Bank’). The author of the research report is Signe Roed-Frederiksen, Senior Analyst.

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Investment Research General Market Conditions FOMC Preview · 2015-10-26 · Important disclosures and certifications are contained from page 8 of this report. Investment Research