The Fed will speak softly, but it still carries a big stick
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Amid the flutter of activity in the political realm — both domestically and internationally — the market appears to be little focused on this week’s Federal Open Market Committee meeting.That’s right; there is a two-day Federal Reserve meeting this week concluding on Wednesday.  

The policy meeting, however, has hardly been greeted with the level of anticipation preceding March’s Fed meeting, which proved to be a daily market moving event in the weeks and days leading up the policy announcement. In part, the lack of excitement this month stems from a growing comfortability surrounding an anticipated lack of policy action at Fed meetings that offer neither updated projections nor a press conference.

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Recall, the Fed only offers supporting documentation and commentary at every other meeting, so this month the market will need to rely on the statement alone to assess or reassess any changes in policy, tone and characterization of the underlying economy.  

 

While a statement will be released at the May meeting, the market is simply anticipating the committee to reiterate last meeting’s message of a continued “moderate” economy with pockets of improvement, further justifying a slow and “gradual” removal of accommodation.

The Fed is likely to acknowledge the recent slowdown in hiring after a disappointing showing in March; however, the moderate characterization of topline job creation is likely to be offset by the committee’s focus on a continued decline in the unemployment rate still bouncing along the Fed’s lower bound of what has been established as the full-employment range.  

Continuing, with back-to-back months of negative consumer activity, the Fed is likely to temper their previous language suggesting household spending has “continued to rise moderately,” while maintaining their more modest assessment of business investment. Additionally, given the recent rise in inflation back above the Fed’s 2-percent target, the statement is likely to highlight the recent increase in price metrics toward the committee’s target while noting that the core level of prices remains little changed. 

The Fed has been hesitant to overplay the recent rise in headline prices given the vast majority of the increase has reflected a reversal in energy prices from a low in January 2016, boosting the base for the year-over-year calculation. As prices stabilize, however, the pressure added to the headline will subside, likely pulling inflation back below the 2 percent threshold in the coming months.

Overall, the Fed is likely to maintain a “moderate” assessment of top-line activity in the U.S. economy. The committee is unlikely to entirely dismiss first-quarter weakness — recall first-quarter (Q1) GDP came in well under expectations; however, the Fed is unlikely to look at one quarter’s weakness as indicative of a longer-term trend without further confirmation of a slowdown extending into Q2 or beyond. 

Aside from the Fed’s latest characterization of growth, against the backdrop of a sluggish first quarter, the statement could reveal or further highlight an increased attention to the balance sheet. As the latest round of Fed commentary indicates, many officials would favor shrinking the central bank’s balance sheet as early as later this year.

Many participants, however, have emphasized that reducing the size of the balance sheet, like direct rate adjustments, should be conducted in a "passive and predictable manner," with clear communication to the market beforehand as to officials’ intentions. In other words, more important than the devised plan itself or the proposed timeline to move forward, the committee must first and foremost articulate said plan to investors in order to eliminate — or at least mitigate — unease and confusion. 

Thus far, however, Fed commentary surrounding how to address the balance sheet has been light on specifics. As the March FOMC meeting minutes suggested, participants generally agreed that a "phase out" of both Treasury securities and agency mortgage-backed securities at the same time would cause less volatility in the market. Although, while simpler for the market in terms of disruption, some policymakers judged that communicating a slower, "phase out" plan to market participants may prove more difficult. 

In the end, the committee has yet to make any decisions regarding the balance sheet, the conversation, however, is likely to be renewed at this week’s meeting. Still, we don’t anticipate the May statement will fill in much of the gap in terms of timing or logistics; while Fed officials appear increasingly ready and focused to address the $4.5 trillion balance sheet, a statement alone seems an inferior platform to announce any type of plan or timeline for such a key policy directive.

Thus, this week’s policy announcement is widely expected to come and go with a muted — if any — market reaction. 

 

Lindsey Piegza, Ph.D., is the chief economist for Stifel Fixed Income Capital Markets Group


The views expressed by contributors are their own and not the views of The Hill.