Fed Preview

The Federal Reserve begins a two day policy meeting today. While it is highly unlikely that there will be a substantive change in policy or the guidance which suggests that rates will likely remain low for an extended period.

That said, investors should expect some changes in the Fed's economic assessment. While the FOMC is still likely to anticipate moderate growth, it may tweak several factors lower, giving a softer cast its overall assessment. For example, previously it said that "growth in household spending has picked up", but now after two disappointing retail sales reports, the Fed may downgrade its assessment. Housing starts also appear weaker than the Fed previously noted. Financial markets are somewhat less supportive of the economy as well, with LIBOR having risen and the equity market roughly 10% lower than when it met last time. Global factors are also not as supportive, given recent European developments.

Since the FOMC's last meeting, price pressures have slackened. Core CPI has fallen in two consecutive months. The year-over-year core CPI stands at 0.9%. Core inflation measures may be weighed down by the ongoing adjustment in the housing market, but this seems to influence the overall magnitude of the decline, though not the general direction. In terms of inflation expectations, when the FOMC meeting late April the 5-yr/5-yr forward was just above 3.0%. It has fallen about 50 bp since then.

Nevertheless, talk that the FOMC may contemplate renewed QE strikes us as premature. Indeed, it should not be surprising if Hoenig from the Kansas City Fed repeats his dissent from the guidance that economic conditions will likely allow rates to remain extraordinarily low for an extended period. It would be surprising if another voting member on the FOMC joined Hoenig and that surprise would likely weigh on the short-end of the US curve, at least initially.