Fed significantly upgrades economic outlook but still projects stable policy through 2023
The key event over the past 24 hours was obviously the Fed’s FOMC policy announcement, revised economic and policy projections and Chair Powell’s post-meeting press conference. The message was certainly dovish, with the dot plots continuing to signal steady policy through to 2023 despite a much stronger growth outlook – an arguably inconsistent picture that might reflect the Fed’s current wariness of triggering an accelerated bond-market adjustment, albeit one justified by Powell in terms of the continued significant uncertainty of the outlook.
As widely expected, of course, the committee held the target fed funds rate at 0-¼% – a rate that the Fed continues to expect will be appropriate until labour market conditions have reached levels consistent with the Committee’s assessment of maximum employment and inflation has risen to 2% and is on track to moderately exceed 2% for some time. The Fed’s QE programme was similarly unchanged, with the committee signalling that it will continue to increase its holdings of USTs 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”. During his press conference, Powell stated that it was still too soon to even begin to talk about tapering those purchases, but again reassured investors that he would communicate any future decision to begin tapering well before such changes are implemented.
Turning to the economic outlook, the Fed noted that “indicators of economic activity and employment have turned up recently”. So combined with recent favourable trends in coronavirus infections and the vaccination programme and the expected impact of the significant additional fiscal stimulus, the Fed inevitably revised up its forecast for GDP growth in the current year. Indeed, the median FOMC participant now expects growth of 6.5% this year – up a hefty 2.3ppts from the forecast made in December. However, the median growth forecast for 2022 was revised up just 0.1ppt to 3.3% and that for 2023 was revised down 0.2ppts to 2.2% (the Fed’s assumption for long-run growth remains 1.8%).
Nonetheless, the much-improved near-term growth outlook means that the median participant now expects the unemployment rate to end this year at 4.5%, down from the 5.0% rate forecast in December. Forecasts for subsequent years were revised down less, by 0.3ppts and 0.2ppts in 2022 and 2023 respectively to 3.9% and 3.5%. This means that the unemployment rate is below the assumed long-run level (4.0%, revised down 0.1ppt) for the final two years of the forecast. However, importantly, Powell made clear that the Fed regards the U-3 measure as understating the full degree of slack in the labour market at present given that labour force participation is presently sitting well-below pre-pandemic levels.
Crucially – and perhaps conveniently or indeed tactically given the Fed’s determination to maintain accommodative conditions – beyond this year the improved outlook for growth and the labour market is forecast to have little payoff in terms of generating higher inflation. While the Fed’s forecast for core PCE inflation this year was revised up 0.4ppts to 2.2%, the forecast for the subsequent two years was revised up just 0.1ppt to 2.0% and 2.1% respectively – barely meeting the Fed’s target of achieving inflation moderately above 2%. Therefore, 11 of the 18 FOMC participants expect the targeted fed funds rate to remain at its current level through 2023, little changed from the 12 of 17 participants that held this expectation previously (Governor Waller joined the Fed after the December projections were published). That said, it is worth noting that 5 of the 7 participants expecting tightening are projecting three or four hikes of 25bps apiece during that year. Just 4 of 18 participants expect an even earlier ‘lift-off’ in 2022, albeit up from 1 of 17 previously, with 3 of those participants expecting a solitary 25bp hike.
Importantly, Powell emphasised that the dot plot represents neither a promise nor a commitment and that the Fed’s outlook for policy will respond to the incoming economic data. So, appropriately, he discouraged investors from reading too much into the forecasts later in the projection period, especially given the significant uncertainty that continues to surround the economic outlook. Indeed, given that uncertainty, Powell also reminded that the Fed’s policy actions will be guided more by developments in the actual data – which he acknowledged are set to improve markedly – and less by what might be suggested by uncertain forecasts.
Finally, it is worth noting that the Fed made no announcement today on whether it will extend the current Supplementary Leverage Ratio exemption applying to financial institutions’ Treasury holdings (and also deposits at the Fed), which is scheduled to expire at the end of this month. However, Powell indicated that a separate announcement on this issue will be made over coming days. This might suggest that the Fed was worried that its decision on this issue – perhaps to end the exemption – would risk adding upward pressure on Treasury yields on a day when it was seeking to communicate a more upbeat economic outlook without triggering a sell-off in the bond market. That said, when asked directly during the press conference, Powell did not indicate any particular discomfort with the current level of bond yields, saying again only that he would be concerned should disorderly conditions threaten the achievement of the Fed’s goals. And he indicated that in his judgment the broad level of financial conditions remains highly accommodative and consistent with what the Fed is seeking, suggesting that no thought is being given to altering the composition of its asset purchases.
US equities and Treasuries reverse earlier losses as Fed maintains dovish policy outlook
Both Wall Street and the Treasury markets were trading nervously going into yesterday’s Fed policy announcement, with the S&P500 down as much as 0.7% and the 10Y UST hitting a high of 1.69% (the 30Y bond trading at almost 2.46%). However, with the Fed largely maintaining its dovish policy stance, the S&P500 eventually closed with a modest 0.3% gain – lifting the index to a new closing high – and the 10Y UST fell back to 1.65% (still up a couple of basis points on the day). The Fed’s commentary weighed on the greenback, with the Antipodean currencies gaining most but the euro, sterling and yen making solid gains too.
During what was a relatively quiet day for local economic news, markets in Asia have welcomed the Fed’s dovish messaging. In Japan, where investors are now awaiting tomorrow’s BoJ policy review, the TOPIX advanced a solid 1.2% to also make a new record high. With recent comments made by Governor Kuroda having conditioned the market to expect the BoJ to announce no more than modest tweaks to its ETF and JGB purchase operations, JGB yields initially drifted lower. However, after the lunch break the 10Y yield spiked up 4bps to a peak of 0.13% – before subsequently falling back to just below 0.11% – after a Nikkei newspaper report suggesting that the BoJ may yet announce a modest widening of the permissible trading range for the 10Y bond. According to that report, sources told Nikkei that a range of ±0.25% might be allowed, up from ±0.2% at present, to help boost bank profitability (not surprisingly, financial stocks led the TOPIX higher today). Outside of Japan, most bourses in the region made gains, with China’s CSI300 closing up 0.8%.
In the Antipodes, another bumper employment report lowered Australia’s unemployment rate by no less than 0.5ppts to 5.8% – a rate that the RBA had not expected to see until next year. So with Aussie bonds already pressured by the slight lift in UST yields since yesterday’s local close, the 10Y ACGB closed 7bps higher at 1.78%. Meanwhile, with the Aussie dollar added to its greenback-driven gains, the ASX200 bucked the trend to close down 0.7%. Kiwi bond yields also finished slightly higher despite news of a 1.0%Q/Q decline in New Zealand’s headline GDP measure in Q4, compared with market expectations of a broadly flat outcome. And while a further modest decline in the current quarter would not surprise, disappointment with this belated measure of activity appeared to be offset by reports that a quarantine-free travel bubble with Australia might be in place as soon as mid-April, providing considerable relief to the hospitality sector.
BoE to leave policy steady and guidance little changed today, while being relaxed about recent Gilt curve steepening
After yesterday’s spotlight on the Fed, today attention turns to the BoE, whose latest monetary policy announcement will be made at lunchtime in the UK. Just like the Fed, steady as she goes seems likely to be the MPC’s message.
Since the Bank published updated forecasts following its previous MPC meeting on 4 February, economic activity appears to have been somewhat firmer than it expected, while inflation has been broadly in line with the Bank’s expectation. And while Gilt yields are up significantly since then – with the 10Y yield yesterday roughly 45bps higher from just before the MPC’s February announcement – Governor Bailey recently stated that the market moves appear broadly consistent with an improved economic outlook. Indeed, the near-term path for fiscal policy will be more supportive than the BoE had assumed in its forecast and the unemployment profile will likely undershoot the path set out in its projection. And while Governor Bailey recently emphasised the significant uncertainty still surrounding the economic outlook, the main thrust of the BoE’s forecasts for the coming couple of years – with GDP rising above the pre-Covid level early in 2022 and inflation returning close to the 2.0%Y/Y target this year and remaining thereabouts – still appears valid.
As such, there will certainly be no change to policy today. And while there is the risk of a slightly more hawkish tone, and markets will no doubt watch closely any additional commentary about bond market developments, we expect the MPC’s forward guidance to be left unchanged too. So, it will likely continue to state that “If the outlook for inflation weakens the Committee stands ready to take whatever additional action is necessary to achieve its remit” and that the “Committee does not intend to tighten monetary policy at least until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.”
Euro area trade surplus to reach new series high as imports from the UK plunge
The euro area data-flow today brings figures for goods trade in January and labour costs in Q4. With exports likely again to have outpaced imports, the trade surplus on an adjusted basis is expected to rise to a new series high from €27.5bn in December. Weakness in imports is likely to be accentuated by the impact of the end of the Brexit transition period – data released on Friday showed that UK goods exports to the EU fell a marked 40.7%M/M while UK imports from the EU fell 28.8%M/M. Meanwhile, as in Q1 and Q2, today’s labour cost figures are likely to be affected significantly by pandemic containment policies, which restricted the number of hours worked in Q4. As such, we look for an acceleration in euro area labour cost growth back above 3.5%Y/Y in Q4 from just 1.7%Y/Y in Q3.
Attention turns back to the economic data in the US
With the Fed emphasising the conditionality of its policy stance on developments in the economy, attention today will turn immediately to the incoming economic data. However, today’s docket is relatively light, with the main diary entries of note being the Philadelphia Fed’s manufacturing survey for March and the Conference Board’s leading indicator for February. The weekly jobless claims data will also be of interest, especially after last week’s instalment pointed to a 4-month low for initial claims.
Aussie employment surges in February, dropping the unemployment rate to 5.8%
The domestic focus in Australia today was on the labour market, the evolution of which holds the key to how the RBA’s monetary policy stance will unfold this year. Given a rise in job advertising to the highest level in more than two years, analysts were looking for a strong Labour Force report in February and these expectations were certainly not disappointed. Indeed, employment grew a further 89k in February – triple market expectations – thus returning almost exactly to where it had stood a year earlier before the pandemic took hold.
Even more encouraging, all of the growth in February was in full-time employment, which now stands just over 5k higher than a year earlier. Part-time employment was essentially unchanged in February and just slightly below the pre-pandemic level. Importantly growth was broad-based across the country, with the most populous states all recording monthly employment growth at or close to 1%M/M. Meanwhile, after slumping in January as more Australians than usual elected to take a summer holiday, aggregate hours worked jumped 6.1%M/M. As a result, hours worked increase 0.2%Y/Y – the first time that annual growth has been positive since March last year.
With the labour force participation rate steady at a record high of 66.1%, the very strong lift in employment translated through to a steep 0.5ppt decline in the unemployment rate to an 11-month low of 5.8% (the previous month was revised down 0.1ppts to 6.3%). By contrast, in its recent Statement on Monetary Policy, the RBA had forecast that such an unemployment rate would not be reached until the first half of next year. While the underemployment rate – which captures those who are working less hours than they would like or in jobs for which they are overqualified – sits somewhat higher at 8.5%, this is in fact 0.1ppts lower than a year earlier and just 1.0ppts above its long-term average.
Needless to say, the continuation of positive surprises from the labour market should please the RBA’s Board, which has made clear that it views lowering the unemployment rate as an important national priority. However, a tighter-than-expected labour market – and so the prospect of a more rapid lift in wages and inflation – clearly has implications for the Board’s longer-term policy outlook, even if underlying inflation is still likely to remain below target-consistent levels for another couple of years. In the near-term, the key pressure point will be the Board’s decision on whether to retain the present 0.1% target for the 3Y bond rate – implying a continued expectation of no policy tightening for at least three years – once that bond rolls to become the November 2024 maturity. In our view, given recent trends – strongly reaffirmed by today’s data – the current 3Y bond rate target would appear to be on borrowed time (after today’s data the November 2024 yields 0.31%, implying that investors see some scope for policy tightening). Investors will now await the RBA’s April Board meeting to see how the Board interprets the latest surprise.
Kiwi GDP pulls back in Q4 following a record rebound in Q3
Following a record 13.9%Q/Q rebound in Q3 – just 0.1ppt less than estimated previously – the Kiwi economy contracted 1.0%Q/Q in Q4, leaving activity down 0.9%Y/Y (measured on a production-basis). While a range of partial indicators had indicated a modest pullback in activity, this outcome was below the more optimistic 0.2%Q/Q growth forecast by the consensus and the flat outcome pencilled in by the RBNZ in last month’s revised projections. For the full calendar year, output declined 2.9% reflecting the pandemic-induced contraction during the first half of the year. In the detail, the largest negative contribution to value added came from the construction sector, where an 8.7%Q/Q decline in activity subtracted 0.6ppts from growth. The other 0.4ppts was accounted for by a 5.0%Q/Q decline in activity in the retail trade and accommodation sector, which had been the beneficiary of a particularly strong rebound in activity during Q3. A mix of offsetting gains and losses was seen elsewhere across the economy.
While conceptually measuring the same thing, the expenditure-based measure of GDP – which tends to be more volatile – fell a slightly greater 1.5%Q/Q in Q4. But coming of the back of an even larger 14.3%Q/Q rebound in Q4, output on this measure was up 1.2%Y/Y. In the detail, private consumption increased a further 1.0%Q/Q – outperforming the retail sector due to a further 3.8%Q/Q recovery in spending on services – while a 1.7%Q/Q lift in government consumption and a 1.9%Q/Q lift in residential building also contributed positively to growth. However, business investment fell 3.1%Q/Q – commercial construction, infrastructure spending and plant and machinery all declining – and a sharp rebound in imports mean that net exports subtracted around 2ppts from growth.
Needless to say, these data are extremely dated, applying to a period that ended almost 3 months ago, and so we would expect today’s report to have limited impact on the RBNZ’s thinking. Of much greater importance will be next month’s quarterly employment data, which will cast light on activity in the present quarter and on whether the surprisingly rapid retightening of labour market conditions has been sustained following a summer without any foreign tourist trade. In some good news for the tourism sector, local media have reported today that a quarantine-free travel bubble may be agreed with Australia from the middle of next month, which would certainly go some way to lifting spirits in the hospitality sector (Australia accounted for around 40% of visitor arrivals prior to the pandemic and even stronger numbers can be expected once quarantine-free travel is available).