Last night’s Fed minutes were almost as dull as the Argentina vs Netherlands match and will hopefully be as quickly forgotten. The broad overall message within the FOMC’s conversations were that, as long as the US economy stays on track then the Federal Reserve will do too.
In the short term that means that we will be seeing the Fed’s 3rd quantitative easing program ending in October with a final taper of $15bn. “If the economy progresses about as the Committee expects, warranting reductions in the pace of purchases at each upcoming meeting, this final reduction would occur following the October meeting,” say the minutes. Some had believed this QE program would run for ever, some that it would end last year. It all depends on the data. While the FOMC were not overly joyous with the falls in the jobless rate, they were equally unworried about the relative torpor seen in inflation markets. The sense from this meeting is a Federal Reserve that will err on the side of caution into September’s meeting.
By then we will have received two readouts of US GDP for Q2, two additional PCE inflation readings and two further jobs reports. It seems there is an equal split within the committee as to those who believe that the jobless rate is a true reflection of slack in the US economy and those who believe that the level of slack is a lot higher given the amount of people in low-paid, part-time work. Those looking for the USD to strengthen will be looking for these reports to quell these fears.
A lot of time was also spent on discussing how the Federal Reserve will exit its QE plan with the Fed looking likely to reinvest capital proceeds well after interest rates have started rising in the United States. All in all, as expected.
The USD reaction was a slight strengthening and then weakness through the Asian session as investors maintained bets that a cessation of QE doesnt immediately point to interest rate increases. Expectations of when the Fed will raise rates are all over the curve at the moment and vary from Q1 2015 to Q2 2016. Much like we have seen a contraction in the range of expectations around rate increases here in the UK – somewhere between Q4 14 and Q2 15 – we expect similar to take place in the US. The market will only do this as a result of two things; an increase in inflation expectations and hawkish noises from the Fed. Both of these go hand in hand and should current trends of job market tightening continue then the Fed will have to take notice.
Mario Draghi’s speech in London was unremarkable apart from comments around the level of the euro. Draghi said that exchange rate behaviour was “among the threats for prices” in the Eurozone. This is not anything new but instead a calculated political tipping of the hat to French businesses that have expressed a desire for an aggressive European Central Bank policy to weaken the single currency to aid exports.
Australian unemployment rose to an 11yr high overnight of 6%. This is despite 15,900 jobs being added in the month of June, higher than the 12,000 expected. The recent NAB business confidence survey preempted such a move but AUD has come lower as market participants just shaded bets that the Reserve Bank of Australia’s policy would in anyway tighten anytime soon. This slight softening will be welcome and as the RBA said last week, currency “is offering less assistance than it might in achieving balanced growth in the economy.”
The Bank of England meetings will become more exciting as the year goes on but today is not set to begin that trend. In fact, the minutes due in a fortnight’s time will make for more interesting reading as the trade-off between a rocketing jobs market and depressed inflation market are balanced up by the Monetary Policy Committee.
The improving jobs market has come without a similar recovery in wages as we have often pointed out. The latest jobs report showed wages had slipped to a growth level of 0.7%. While it may too early to tell as to how much effect this is having on inflation in the near term we must realise that the inflation metrics – particularly core prices – will be weak moving forward should wages not come higher.
Another influence on near-term inflation is sterling. The pound has been on a seemingly relentless march for 15 months now and the trade-weighted index is currently running at the highest levels since Lehman Brothers went under. Cheaper imports are all well and good but a continuation of the GBP increase will push overall CPI lower in the coming months, especially should we see a steeper slide in the value of the euro through Q3.
Given recent data however we may be only a month or so away from the first votes of dissent against Carney’s plans.
