Global Daily – Fed still focused on downside risks

by: Bill Diviney , Nick Kounis , Aline Schuiling

Fed View: Communication tweaks, but still dovish – The FOMC kept rates on hold today, signalled broad comfort with the current policy stance, and there were only marginal changes to the quarterly projections (which continue to show a slightly upward-sloping rate path beyond 2020). So far, as expected. There were some modest tweaks to the policy statement, however, including a surprise removal of the phrase that ‘uncertainties remain’ to the outlook. At first glance, this appeared to be a conscious shift from an easing bias. However – and as flagged by Chair Powell in the press conference – the Committee later made a new reference to ‘global developments [i.e. the trade war] and muted inflation pressures’ as among the factors the Fed will monitor. This suggests a continued focus on the downside – rather than the upside – risks to the outlook, making the change overall one of semantics rather than substance.

Indeed, with Treasury yields moving modestly lower and rate cut expectations increasing a touch (c. 2-3bp), markets seemed to focus more on some rather dovish comments from Chair Powell in the press conference, including his remark that ‘inflation persistently below 2% could be unhealthy’, as it would reduce the policy space the Fed might have in dealing with any future downturn. Combined with what the FOMC minutes have been telling us recently on the review of the Fed’s policy framework, this suggests an increased tolerance for potentially above-target inflation in future – should that materialise – and that the Fed would be in no hurry to hike rates to fight such inflationary pressure. Looking ahead, we continue to expect weaker growth to drive one more rate cut by the Fed in Q1 2020, with policy likely on hold thereafter. (Bill Diviney)

ECB Preview: No change in policy in December but further easing seen in March – Christine Lagarde’s first monetary policy meeting as President will not likely lead to new policy actions. However, there are reasons to think that the door will be left wide open for further monetary easing next year. The ECB is likely to present forecasts showing inflation undershooting its goal over the coming years. In September, the staff projected inflation undershooting the target even at the end of 2021 (at 1.5%). The Governing Council hoped that the September stimulus package would have led to an easing of financial conditions to correct the undershoot, but the opposite actually happened. In addition, the central bank’s growth projections for the first half of next year look optimistic given the momentum of the economy towards the end of this year, so we could see the profile downgraded. The discussion in the October Governing Council meeting hinted in this direction. The ECB will publish its inflation projection for 2022 for the first time, but it is difficult to make a case that it will be close to the inflation goal. Overall, its projections should point to additional monetary stimulus in the coming months.

Some commentators have suggested that fiscal stimulus is on the cards that will allow the ECB to stay on the side-lines next year. No doubt this is what Ms. Lagarde and others Governing Council members would prefer. However, there is little sign of this in reality. Government plans to date point to a fiscal easing for the eurozone as a whole of 0.2% GDP in 2020, which is negligible. Another argument for the ECB to maintain the status quo is the upcoming review of the ECB’s inflation goal and tools. Again, we do not buy this argument. The review (which will probably be announced in January) will likely take a long time, and the ECB cannot put its monetary policy on ice in the meantime.

We continue to think that the ECB will decide in March to cut its deposit rate by 10bp and step up the pace of net asset purchases to EUR 40bn a month from April 2020. In addition, we expect a further loosening of the terms of TLTRO-III, most likely a further increase in the maturity. (Nick Kounis & Aline Schuiling)