Global Daily – Fed set to shift guidance

by: Nick Kounis , Aline Schuiling , Peter de Bruin

Global-Daily-Insight-19-March-2014.pdf ()
  • Fed set to continue tapering of asset purchases, shift towards more qualitative guidance
  • US core inflation remains on modest downward trend, but should trend higher at the end of the year
  • Germany’s ZEW indicator drops


Fed could drop unemployment threshold in favour of more qualitative guidance

The FOMC meets today. We expect it to continue to reduce the monthly amount of its asset purchases. In recent communication, officials have suggested that they still suspected that the patch of weak US data is due to the weather and that the bar to pausing the tapering of asset purchases is relatively high. In addition, the most recent economic numbers have provided tentative evidence that economic growth is starting to regain some momentum. Overall, we think that monthly purchases of Treasury securities will likely be reduced by USD 5bn to USD 30bn and those of mortgage backed securities by USD 5bn to USD 25bn. Meanwhile, the FOMC might also change its forward guidance in the statement. It could already drop the unemployment rate threshold of 6.5% (which has already been downplayed over recent months) in favour of a more qualitative guidance based on the state of the economy, labour market and inflation more widely. Looking forward, we expect US economic growth to accelerate strongly in coming months. Against this background, we think a gradual tapering will continue, with the programme coming to a halt at the October FOMC. In addition, we see the first policy rate hike at around the middle of next year, which is somewhat earlier than currently priced into financial markets reflecting our above-consensus view on growth, which should lead to further significant falls in unemployment.

US inflation falls on energy, but core stable

With the Fed likely to move to a more qualitative forward guidance, we think that financial markets will start to focus more on inflationary developments in the US. That is why we will start covering this topic more closely on these pages from now onwards. In February, headline consumer prices rose by 0.1% mom, after a 0.1% gain the month before. This reflected that a 0.4% increase in food prices was offset by a 0.5% drop in energy prices, while core consumer prices rose by 0.1% for the third consecutive month in a row. Due to negative base effects, annual headline inflation fell from 1.6% to 1.1% in February. Meanwhile, core inflation remained stable at 1.6%, though the series continues to trend down modestly. This reflects that rises in shelter inflation have been more than offset by declines in core goods inflation and services inflation. Looking forward, we continue to think that there is only limited spare capacity in the economy. Although gains in productivity will offset part of  the rise in wages for some time to come, we think that eventually services inflation will start to increase again. Admittedly, as more homes will continue to be build, shelter inflation should start to reverse somewhat, but we expect that towards the end of the year core inflation will start to trend up more meaningfully.

Germany’s ZEW indicator drops

Germany’s ZEW expectations indicator fell to 46.6 in March from 55.7 in February. Sentiment was probably hit by worries about the Ukraine conflict, the strong euro, the lack of policy easing by the ECB earlier this month and doubts about the strength of the Chinese economy following a string of disappointing data from China. The details of the report show that the percentage of participants to the survey that forecast an appreciation of the USD versus the euro fell by 5 percentage points, while the percentage forecasting a depreciation of the dollar increased by 1.5 pp. Meanwhile, the percentage of participants expecting ‘no change’ in short-term interest rates rose by 10 pp to 80%. Despite its decline, the ZEW indicator remains well above its long-term average value and at a level consistent with strong growth of the German economy. We expect GDP growth to have picked-up somewhat in the first quarter of this year (we have penciled in 0.6% qoq), as mild winter weather probably gave an extra boost to the already robustly growing economy.

Daily 19 March