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Eco Focus is an aperiodic publication providing up-to-the-minute analysis of a current topic.
The FOMC, as widely expected, opted for unchanged policy at its September meeting with the Fed funds target range maintained at 0.25% to 0.50%. Market participants saw a relatively low probability for a rate hike with policymakers split over the near-term rate normalization path. We look for the FOMC to hike the Fed funds rate by 25 bps on 14- December. Chair Yellen's comment that the case for a rate hike has strengthened was echoed in the statement. Moreover, the FOMC noted that the "near-term risks to the economic outlook appear roughly balanced."
The ECB did not officially extend QE, but they clearly pointed towards a change in the modalities over the near-term ("tasked the relevant committee"); we see it as a step towards an official extension in October or in December this year, along with an easing of purchase modalities, probably a removal of the deposit rate floor.
Paradoxically, the six-month 'official' extension of QE is insignificant, despite amounting to EUR480bn: QE is already in open-ended mode and markets are already convinced that it will run beyond March 2017. As long as markets continue to expect the extension, the timing of its announcement matters little. President Mario Draghi will, we expect, point to the extension on Thursday to ensure this remains the case.
In spite of a renewed extension of the deadline to correct the deficit, full compliance with the Stability and Growth Pact is still at risk given the current political deadlock. Until a consensus about constitutional, geographical and fiscal reforms is reached, political uncertainty will linger and weigh on fiscal metrics. Sustained nominal growth and exceptionally favourable financing conditions should nonetheless allow the fiscal deficit to decrease gradually.
FOMC voters thought it was appropriate to wait for additional information in order to gauge the underlying momentum in the labor market and economic activity before taking another step in removing monetary accommodation. "Most participants anticipated that economic growth would move up to a rate somewhat above its longer-run trend during the second half of 2016 and that the labor market would strengthen further." We believe that Chair Yellen is willing to test the downside of the natural rate of unemployment in order to meet the Fed's maximum employment mandate.
We have analysed the scarcity issue for German bonds as it is the most obvious impediment to the smooth running of the purchase programme until a suitable end time. Our conclusion was not extremely reassuring as it pointed to difficulties for the ECB starting this winter.
July nonfarm payrolls rose by a robust 255K. The 3-month moving average of payroll gains moved up to 190K in July. We look for average monthly payroll gains to decelerate this year with the economy near full employment. The July unemployment rate was unchanged at 4.9%. Alternative labor slack measures were generally stable. The participation rate rose to 62.8%.
On 4 August, the Bank of England lowered its key policy rate by 25bp to 0.25% as a response to the expectation of a Brexit-induced weakness in demand. Furthermore, it delivered a package of unconventional measures aiming to provide additional support to growth. These included a restart of the purchases of government bonds to the tune of GBP60bn, the purchase of corporate bonds (up to GBP10bn) and a new Term Funding Scheme.
Most political pundits look for Hillary Clinton to win the November election and be sworn in as the 45th President of the United Sates on January 20, 2017. Current poll results suggest that the electoral path to victory for Donald Trump is possible but much more difficult. Additional state polls will be needed to clarify the odds as we move closer to the November 8th election.
The FOMC maintained its current monetary policy settings today, in line with market expectations. Neither the 0.25% to 0.50% Fed funds target range nor the Fed's current portfolio reinvestment policies were changed. The assessment of current economic conditions in the policy statement was more upbeat, reflecting stronger job gains in June and an expected acceleration in Q2 real GDP growth to be reported on Friday.
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