Market Watch

Big week: End of the month, the start of a new one. Brace for central bank meetings, US inflation and employment reads, and the ‘sell in May and go away’ line to be rolled out everywhere as it is every year (valuations are ‘tight’ though so the prophecy might actually come to fruition). 

Central questions for central banks

The Federal Open Market Committee (FOMC)

Being a ‘non-testimony’ month, both the market and economists are forecasting no change to the FOMC's Federal Funds target rate in the US. 

Nevertheless, the statement will be trawled over and over. Any hints or signs of a more hawkish board will move the dial on the current rate hike trajectory forecasts.

Movements in the Federal Funds rate over the past six months have finally caused credit and fixed income markets to spike higher (although not the sole reason – tax cuts and geopolitics have played their part). 

The London Interbank Offered Rate (LIBOR) to the Bank Bill Swap Rate (BBSW) have been caught up in increases. Signs of sharper rises in the Federal Funds rate will only compound current trading in these markets. Out-of-cycle rate rises remain a big risk for Australia.

So, what might the FOMC discuss that could catch the market’s attention?

• The Board’s view on the recent tax cuts and infrastructure spending with respect to economic growth. Are these fiscal policies contributing to ‘heating’ the US economy?
• Jobs. The Board might pay mention to the continued acceleration of jobs growth, narrowing slack in the jobs market, and jump in wage inflation. As well, the question could rise as to whether we have reached ‘full employment’. This week’s US non-farm payrolls data comes out after this week’s meeting, however, the signs point to another strong print in average hourly earnings.
• Inflation acceleration. US inflation is poised to pass the Fed’s second mandate of 2 per cent inflation. This week’s personal consumption expenditures (PCE) inflation read for the month of March is due on Monday, and the print has seen upside pressure of late due to wages increases. The Board is acutely aware that ‘runaway inflation’ will cause an acceleration of the ‘normalisation’ in the Federal Funds rate – that is why US inflation is the biggest macroeconomic risk to markets, and even the most dovish of FOMC members (i.e. Lael Brainard and Neel Kashkari) are becoming hawkish on inflation.

The Reserve Bank of Australia (RBA) 

The RBA is now the most ‘stable’ bank on rates in the developed world. Of all the G10 central banks, the RBA is the most neutral and constrained by data versus a desire to increase rates. 

This neutral standing has forced the most hawkish economists to move their expectations of rate rises right out. Three economists had a 25-basis point rate rise pencilled in for Tuesday. There is now no one forecasting a move for tomorrow; we must move all the way to November to see more than one economist forecasting a rate rise in 2018. (I can’t see a single move before Christmas; economic momentum is fragile and inflation is below trend.) 

The interbank and swaps market both see no chance of a hike on Tuesday; in fact, both markets have less than a 50 per cent chance of a rate movement in the next 12 months. However, there is hedging built into these markets, which suggests the probability for hikes could be even lower in reality.

The market will be looking for the following in the statement:

• Rate direction. The Board is likely to highlight the direction of the global economy, rates in the US, and China’s continual development. The RBA has been open about its desire to raise rates, as global developments have been assisting the local economy. However, the Board will moderate its view in the case of domestic slack.
• GDP. The Board has begun to use language that would give the RBA room to cut its forecasted growth rate for 2018. Data in March and April are likely to sharpen the Board’s pencil to move from a targeted 3.25 per cent to 3 per cent.
• Consumption. Previous statements and minutes have been positive on household consumption, but April’s consumer data showed some weakness. This feeds into GDP and inflation, as slowing consumption makes for slower growth.
• Labour market. Slack remains the thorn in the side of the RBA’s core mandate – inflation. The RBA has remained upbeat about employment, noting it is expecting ‘gradual improvements’. But the Board has acknowledged that wages and employment slack remain above forecasts.