There was no surprise when the US Federal Reserve left interest rates near zero at its meeting this morning. This was expected by everyone, yes everyone, in the market.
The interesting and market moving part of what the Fed said was its commitment to keep buying $US85 billion of bonds each month and in a new development, it indicated that it may either “increase or reduce the pace of its [bond] purchases to maintain the appropriate policy accommodation”.
In other words, the Fed will continue to do whatever it takes to meets its current objectives of 6.5 per cent unemployment and inflation around 2 per cent.
This was the first time that Fed noted the possibility or risk of having to ramp up its bond purchases or quantitative easing. The reason for this relatively dovish inclusion is that the Fed still sees downside risks in the economy. In particular, the Fed noted that the economy is expanding only “at a moderate pace”, and that “fiscal policy is restraining growth”.
In other words, the economic recovery to date from what remains the deepest and most protracted economic slump since the 1930s Great Depression, is tepid. This underwhelming recovery is being further hampered by cuts to government spending and tax increases that are ripping money out of the economy at the very time overall economic growth is moderate.
The Fed also makes the straight-forward but obvious point that inflation is running below its longer run objective of 2 per cent and is likely to do so for the foreseeable future. In other words, inflation is currently too low and is likely to remain too low, a scenario that requires monetary policy to remain on a very easy setting.
The Fed’s policy action and analysis were supported by a run of economic and market news in the US through the day.
First there was the disconcerting economic news on jobs. The ADP private sector employment series registered a tepid 119,000 increase in jobs in April, a result that bodes poorly for the official non-farm payrolls data on Friday. Not only did the April result disappoint, but the prior month was revised lower by 27,000 to an increase of just 131,000 which suggests the pace of job creation is probably stalling from what was a strong end to 2012.
While this jobs survey does not fit perfectly with the monthly official jobs data, overall employment needs to rise by around 175,000 a month for there to be meaningful inroads into reducing the unemployment rate and to catch up on the jobs lost during the recent recession.
At the same time, the Institute of Supply Managers manufacturing index fell to 50.7 points in April from 51.3 points in March to reach a six month low. The level of the index is suggests that growth in manufacturing is faltering.
Oil prices were smashed lower as well, with news of a record jump in the US inventory of oil. The price of West Texas Crude fell around 2.7 per cent to just over $US90 a barrel.
In the commodity markets space, it wasn’t just oil prices that fell. Base metals prices also dropped sharply, reaching their lowest level since July 2010. Nickel and tin prices are now down over 20 per cent from the recent highs registered around six months ago.
Commodity prices are likely to remain weak, hindered by growing supply from the new mines that are coming on stream, and now also from the unimpressive global growth performance and downside risks that are unfolding in the US.
The new dovishness of the Fed will be further put to the test soon with the official jobs data tomorrow while the European Central Bank meeting tonight, Australian time, is likely to be of huge interest for financial markets given the strong likelihood of an interest rate cut.
All up, the US, Europe and the whole global economic environment is one of deflationary funk. Central banks are generally implementing monetary policy at the easiest setting ever seen in history as they fight a duel objective of avoiding deflation whilst at the same time, trying to prop up economic activity that is being hamstrung from the wealth destruction and banking collapses during the crisis.
From what the Federal Reserve said today, it is likely that this super easy monetary policy will remain in place in the US for many years to come, as it no doubt will in the eurozone, Japan and the UK.