- FOMC may sound slightly more dovish on inflation, but should continue to stress strong labour market
- We expect the US labour market to continue improving, confirming our view of rate hike in mid-2015
- S&P cut Russia’s credit rating to junk; a deep recession is inescapable in our view
Fed policymakers meet against background of improving job market, but lower inflation
Since the last FOMC meeting held on December 16-17, there has been further improvements in the labour market data. The unemployment rate is now at 5.6%, below the Fed’s end-of-year forecast, while around 2.9 million jobs were added last year. The strong third quarter GDP growth, of 5% qoq annualised, and above trend growth in the coming quarters will continue to boost the labour market. The latest IMF projections for the US economy confirm our positive view on the outlook. It revised its 2015 GDP growth forecast up by 0.5 percentage points to 3.6. We think that the drag on the economy from a stronger dollar should be offset by lower oil prices. Headline inflation has, however, fallen sharply as a result of the lower energy prices and core inflation has softened a bit in the past few months. In the previous meeting FOMC members revised down their inflation forecasts to reflect the lower energy prices. However, they stressed that the impact of oil prices on inflation would likely be transient, which is also our view. Given that further decline in oil prices since then, we expect FOMC members to adjust tomorrow’s statement to show a slightly more dovish tint on the language on inflation.
Declining labour market slack should put upward pressure on wages, confirming our view of a rate hike in mid-2015
Although the inflation picture may have deteriorated somewhat since the last meeting, we think that Fed members will likely hike rates in mid-2015. Although both market based measures and survey indicators of long-term inflation expectations have edged down, we expect incoming data, particularly core inflation, to firm in the coming months. Some of the recent softness in core inflation is probably reflects volatility around the holiday season. In addition, lower oil prices should add to the positive impetus behind domestic demand, which should lead to a tighter labour market and stronger wage growth. Small business surveys also suggest wage growth will accelerate in the coming months. Even if inflation is well below the Fed’s 2% target in the near term, Fed policymakers have noted that this should not be an impediment to normalising interest rates, as long as core inflation holds up. Indeed the Committee mentioned that “they might begin normalisation at a time when core inflation was at current levels”.
S&P cuts Russia’s rating to junk,…
On Monday, S&P cut Russia’s credit rating by one notch to the highest speculative grade. Both Fitch and Moody’s have also reduced Russia’s rating in the past month, though still see the country at the minimum investment grade level. Russia still benefits from its very low public debt, it’s still sizeable amount of reserves, and relatively low external debt. But, according to S&P, the weakening of Russia’s financial system – with interbank rates hovering above 20% – has limited the central bank’s ability to transmit monetary policy, while the country’s growth prospects have weakened.
….as a deep recession looks inescapable
Indeed, we think that a deep recession is inescapable. In our view, during the ruble crisis at the end of last year, the country experienced a similar shock, as seen during the financial crisis, when the economy contracted by 7.2% in 2009. However, we expect the magnitude of the downturn to be less pronounced than during the financial crisis. Obviously the international background is now more positive. Furthermore, the ruble has depreciated much more substantially, which will hurt imports. Somewhat paradoxically, this implies that net trade will be less of a drag. In addition, the starting point of the economy is weaker, suggesting that there is less room for a deep contraction. As a result, we think that the economy will contract by 4% this year.