Fed makes minimal changes to QE message amidst broadly unchanged outlook

Chris Scicluna

Fed makes minimal changes to QE message amidst broadly unchanged outlook
As widely expected, the final FOMC meeting for this year saw the fed funds rate held at 0-¼% – a target that the Fed continues to expect will be appropriate until (1) labour market conditions have reached levels consistent with the Committee’s assessment of maximum employment and (2) inflation has risen to 2% and is on track to moderately exceed 2% for some time.

Of course, the main interest today was always going to be centred on what the Fed would say about asset purchases. As it turns out, the Fed had little new to say. The Fed merely clarified that it will continue to increase its holdings of USTs at the recent pace, i.e. by at least $80bn per month, and of agency MBS by at least $40bn per month, “until substantial further progress has been made toward the Committee’s maximum employment and price stability goals”. So, the Fed made explicit that future decisions on its asset purchases will be linked directly to economic and financial outcomes, albeit judged only qualitatively not quantitatively, with Chair Powell unwilling to define “substantial further progress” during his post-meeting press conference.

Powell did make clear, however, that more accommodation would be forthcoming if progress towards those goals disappoints, and reminded Congress that the case for further fiscal stimulus is “very, very, strong”. The modest increase in yields after the release of the statement suggests that some market participants expected a more active response, however.

In terms of its economic projections, the Fed inevitably revised down the extent of the expected drop in GDP this year, to -2.4% (from -3.7% previously). But the outlook for growth in future years was little different – just 0.2ppt stronger in each of the coming two years (to 4.2% and 3.2% in 2021 and 2022 respectively). And the forecasts for growth further ahead were shaved down by 0.1ppt to 2.4% in 2023 and just 1.8% over the longer run. While the forecast for the unemployment rate at the end of this year was revised down significantly (by 0.9ppt to 6.7%), the forecasts for coming years were revised down by significantly less, by 0.5ppt and 0.4ppt in 2021 and 2022 respectively to 5.0% and 4.2%. And the unemployment forecast for 2023 was nudged down a little further to 3.7%, below the long-run level (4.1%).

 Crucially, despite that, the Fed still doesn’t expect inflation to rise above 2.0% over the projection horizon. Therefore, 12 of the 17 FOMC participants expect the target rate of the fed funds rate to remain at its current level until end 2023 – just one fewer than was the case previously. And of the five members expecting ‘lift-off’ by end-2023, three of those expect an increase of just 25bps.

Markets somewhat mixed in Asia today, but tone improves through the session
Despite the release of a somewhat disappointing US retail sales report earlier in the day, the prospect of fiscal stimulus meant that Wall had been trading modestly in the black ahead of the FOMC announcement. While that gain was initially unwound as the Fed headlines hit the newswires, at the close the S&P500 was up 0.2% – more-or-less in line with pre-FOMC levels. The 10Y UST yield finished just 1bp above the pre-FOMC level at 0.92%, having traded above 0.94% soon after the FOMC announcement. A spike higher in the greenback after the FOMC announcement was reversed quickly.

US equity futures have gradually firmed a little since Wall Street closed, even as US coronavirus deaths were reported to have topped 3,800 over the past day – tragically, another record high. So with US markets not providing a great deal of direction, the performance of Asian equity markets has been somewhat mixed, albeit with the tone improving the session. At the positive end of the spectrum, China’s CSI300 increased 1.3%, extending its recovery from last week’s week-long decline. By contrast, Japan’s TOPIX increased just 0.3%, with Tokyo raising its medical system alert to ‘under strain’ – the highest level – as new coronavirus cases increased to a fresh high.

In other Japanese news, the Nikkei newspaper reported that next week’s Budget forecast would be based on forecast GDP growth of 4.0% in FY21, up from 3.4% previously, albeit following a contraction in FY20 that would be 0.5ppts deeper than forecast previously. Investors now await tomorrow’s BoJ Policy Board meeting, although the only innovation from the October meeting is likely to be the announcement of 6-month extension to the BoJ’s special financing programme. This was introduced as part of the Bank’s pandemic response, with the aim of lower funding costs to small and medium-sized firms, and currently due to expire at the end of March.

Meanwhile, positive local news lifted risk sentiment in the Antipodes. Australia’s ASX200 increased 1.2% and the Aussie dollar increased to a 2½ year high as job growth once again surprised analysts significantly to the upside and as the Government’s economic and fiscal update revealed some further improvement in the outlook compared to the Budget released just two months ago. Similarly, Kiwi stocks rallied, bond yields rose and the Kiwi dollar appreciated to a 2½-year high as the country’s Q3 GDP rebound exceeded expectations, further reducing the likelihood that the RBNZ will lower the official cash rate next year, let alone into negative territory.

Aussie job growth very strong in November, unemployment rate down to 6.8%
The key focus in the Australia today was on the labour market, with the ABS releasing the Labour Force survey for November. Following last month’s thumping 179k lift in employment, analysts had expected a more restrained 40k increase today – nonetheless, one that in normal times would be considered very strong. Instead, employment grew a further 90k in November – not least due to a further sharp recovery in the state of Victoria – so that the annual decline eased to just 0.6%Y/Y. Indeed, employment is now just 143k below where it stood in February, having increased more than 730k since the low-point was reached in May. Encouragingly, the bulk of the growth in November was in full-time employment, which increased 94k to the highest level since March (albeit still down 161k since February). Part-time employment increased just 6k in November but is already above the pre-pandemic level.

While employment increased a strong 0.7%M/M in November, aggregate hours worked increased an even more impressive 2.5%M/M to the highest level since March (and as a result, is now down just 1.2%Y/Y). In part, the increase in employment during November was made possible by a further 0.3ppt increase in the labour force participation rate to 66.1% – encouragingly, now fractionally above the pre-pandemic level. In addition, employment growth was sufficient to lower the unemployment rate by an unexpected 0.2ppts to a 3-month low of 6.8% – now more than a full percentage point below where last month’s revised RBA forecasts indicated it might stand at the end of this year. This should please the RBA’s Board, which views lowering the unemployment rate as an important national priority. Even so, the unemployment rate remains more than 2ppts above the Bank’s assessment of the full employment level, so it will take many more months of improvement before additional policy easing can be ruled out.

Stronger-than-expected economic data leads to improved Australian fiscal outlook
In other upbeat Aussie news, the Treasury released its Mid-Year Economic and Fiscal Update, updating the forecasts contained in the Budget (released just two months ago in October, due to delays caused by the pandemic). Real GDP is now forecast to decline 2½% this year, rather than the 3¼% decline forecast previously, before growing 4½% next year. As a result, the Treasury now forecasts the unemployment rate to peak at 7½% – probably still too pessimistic given today’s labour force report – rather than the 8% peak foreseen previously. The slightly improved economic outlook flows through to the fiscal bottom line, with the Treasury now expecting a deficit of A$197.7bn (9.9% of GDP) in the current fiscal year, down from the Budget forecast of A$213.7bn (11.0% of GDP). In subsequent years the forecast deficit has also been lowered slightly, and so net debt is now forecast to peak at 43.0% of GDP in 2023/24, down from the previous forecast of 43.8%.

Ahead of today’s BoE MPC announcements, Sterling continues to climb as EU-UK deal appears within grasp
Sterling has continued to appreciate, heading towards $1.36 this morning and more than 2% up on a week ago, with reports suggesting that a deal between the EU and UK is close. With the UK having accepted the principle of managed divergence to maintain a level playing-field, attention appears now to have shifted to resolving the long-standing impasse on fishing rights. A deal seems likely within days, to pave the way to ratification in the UK Parliament next week, possible ratification in the European Parliament between Christmas and New Year, but if not, some form of provisional application from the start of 2021 anyway. Given that optimism, today’s final scheduled BoE MPC meeting of the year should be a non-event, not least as the MPC already agreed last month an increase in its asset purchase programme to last well into the second half of next year. Of course, the MPC would nevertheless seem likely to take stock of its toolkit for possible use in the (now less than likely) event that the EU-UK negotiations fail at the last minute.

Euro area new car registrations on track to drop by one quarter in 2020, French business sentiment firmer
As foreshadowed by the data already released from the large member states, new car registrations in the EU plunged last month as showrooms in many countries were forced to close. In particular, registrations fell 12.0%Y/Y in the EU27 to be down 25.5%YTD/Y in the first eleven months of the year. Unsurprisingly, the figures for the euro area were little different at -12.5%Y/Y and -26.1%YTD/Y, and thus on track for the worst year for several decades. Among the large member states, Germany (down 0.3%Y/Y and 16.2%YTD/Y) fared better than France (-27.0%Y/Y and -26.9%YTD/Y), Italy (-8.3%Y/Y, -29.0%YTD/Y) and Spain (-5.7%Y/Y and -25.0%YTD/Y). And new car registrations were weaker still in the UK (-27.4%Y/Y and -30.7%YTD/Y).

The INSEE French business sentiment survey for December, released a short while ago, tallied with yesterday’s flash PMIs to point to an improvement in activity after the easing of pandemic restrictions this month. In particular, the headline confidence indicator rose more than 11pts, the most since June, to a three-month high of 91.0, still nevertheless well below the long-run average (100). The improvement principally reflected stronger sentiment in services, with manufacturers only a touch more upbeat. While overall expectations about the outlook improved significantly, firms remained pessimistic about their employment intentions.

Later this morning, final November inflation figures for the euro area are expected to align with the flash release which showed the headline and core rates steady for a third month, respectively at -0.3%Y/Y, the lowest level since January 2015, and 0.2%Y/Y, a record low. The final figures from Germany, France and Italy also matched their preliminary estimates but Spain saw a very modest upwards revision.

US focus remains on fiscal stimulus negotiations; housing starts, Philly Fed survey and jobless claims of interest too
With the Fed meeting out of the way, in the absence of some definitive progress in fiscal stimulus negotiations, the attention in the US today will turn back to the economic data. Following on from yesterday’s slightly softer NAHB housing index, Daiwa America Chief Economist Mike Moran expects a modest decline in housing starts to be reported for November, which would nonetheless leave starts at an elevated level relative to the most recent period of expansion. Also of interest today will be the Philadelphia Fed’s manufacturing survey for December (especially after the slight decline in the NY Fed’s survey earlier this week) and the weekly jobless claims report (the latter especially after initial claims hit a 3-month high last week).

Kiwi GDP rebounds 14.0%Q/Q in Q3, above market expectation & up 0.4%Y/Y
Partial indicators had pointed to a very strong rebound in GDP in New Zealand in Q3 as the country emerged from the previous quarter’s national lockdown. As it turns out, the rebound was even stronger than markets had expected, with activity – measured using the favoured production-based approach – increasing 14.0%Q/Q following a Q2 contraction of 11.0%Q/Q (the latter 1.2ppts smaller than estimated previously). As a result, despite the fact that Auckland was under a partial lockdown for part of the quarter, the country returned to positive annual growth in Q3 – albeit just 0.4%Y/Y – compared to the 2%Y/Y decline that had been forecast. The expenditure-based measure of GDP rebounded an even stronger 15.7%Q/Q, led by a 42%Q/Q surge in residential construction, a 27%Q/Q increase in business capex and a near 15%Q/Q increase in private consumption. Net exports subtracted 1.1ppts from growth in the quarter, with a near 11%Q/Q rebound in imports outpacing a 5%Q/Q lift in exports.

Notably, the level of real GDP reached in Q3 was one that the RBNZ had last month forecast would not be reached until Q222. So, while the RBNZ will very likely continue with its current accommodative policy settings – including its bond purchase programme and cheap funding for banks – the probability of the official cash rate being lowered further, potentially into negative territory, was surely reduced by today’s report.

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