The FOMC: Few Changes But Softer Bias

The Fed statement was a bit surprising as the tone on growth and employment was kept fairly unchanged despite the recent weakness in data.

However, they turned slightly more dovish on the policy description as they said that they are prepared to both increase or reduce asset purchases. Hence, it opens a slight door that a rise in asset purchases is also possible should growth deteriorate more than expected.

We expect the Fed to keep the current pace of asset purchases till the end of the year.

Details And Assessment
The biggest surprise in the statement today was the lack of changes. The description of both growth and inflation was kept broadly unchanged despite weaker data recently and a clear decline in inflation to levels far from the Fed’s target.

On growth, the Fed now says “economic activity has been expanding at a moderate pace”. In the March statement they described growth as “moderate”. And similarly on the labour market they still just talk about improvement. This is surprising given a period of clear disappointment in data and softer payrolls growth.

The exact wording on inflation is kept unchanged. The Fed still says inflation is running somewhat below its objective. That is actually a bit of a stretch, as the PCE deflator is clearly below at 1.0% y/y in April and core PCE deflator at 1.1% y/y. The Fed’s target is at 2%. The main change was the added sentence “The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes”.

It opens the door for possible further easing if necessary. But given that their outlook is not changed, it seems a bit strange to add this sentence. But maybe it was a compromise between the hawks and the doves. They kept the description of the economy to signal they are still confident in the outlook. However, at the same time they indicated that policy can now go both ways, both easing as well as tightening, contrary to previous discussion which was about when to scale down on easing.

Outlook
Not the mix we expected but the conclusion is overall the same. Slightly softer tone but easing will take quite a bit of weaker data. As we expect the slowdown to be temporary and that underlying growth dynamics are strengthening (housing strengthening, equity prices higher, wage growth rebounding), we expect the Fed to sit tight through the soft patch and push tapering of asset purchases out to the end of the year rather than the autumn.

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