Investment Research — General Market Conditions
16 March 2015
FOMC preview
Step closer to first rate hike
We expect the key phrase that the FOMC can be patient in beginning to normalize
the stance of monetary policy to be omitted from the statement released on
Wednesday evening. This will mark the final transfer from calendar-based guidance on
monetary policy to full data-dependency. The takeaway from recent Fed statements and
Janet Yellen’s semi-annual testimony to Congress is that removing “patient” does not
signal that rate hikes are coming two meetings later (i.e. in June). But it does give the
Fed the flexibility to raise rates at any time they feel it is justified.
The press conference is going to be interesting, in our view. The big dilemma for the
FOMC currently is that the labour market is improving fast while core inflation is
undershooting the 2% target with no firm signs that the downward trend is about to turn.
On top of this, recent economic data has been on the weak side and it will be interesting
to hear Yellen’s assessment of these conflicting signs.
In her February testimony, Yellen laid out the conditions necessary for rate hikes to
commence (although in rather opaque terms): provided that labor market conditions
continue to improve and further improvement is expected, the Committee anticipates that
it will be appropriate to raise the target range for the federal funds rate when, on the
basis of incoming data, the Committee is reasonably confident that inflation will move
back over the medium term toward our 2 percent objective. It is uncertain when the
FOMC feels that these conditions will be met, but with the labour market now in a
better state on almost all metrics than in June 2004 when the Fed initiated the
previous hiking cycle (see US Labour Market Monitor: Solid but slower job growth ),
we think that the first fed funds rate hike is moving closer.
The challenge is the lack of wage inflation and the low level of core inflation. One
possible explanation for the sluggishness in wage growth is pent-up wage cuts. The
thesis, which has been cited recently by both Yellen and San Francisco Fed President
Williams, is that due to nominal wage rigidities, companies were not able to adjust wages
enough during the downturn and this is now holding back wage increases. The upshot is
that once the adjustment has been done, wages tend to rise rapidly; and there are tentative
signs that wage pressure is building.
Regarding core inflation, low oil prices and the stronger US dollar are both
deflationary and we expect core goods inflation to trend lower in coming months.
However, several FOMC members have highlighted that the Fed needs to look at the
inflation outlook and the current drivers of low core inflation are temporary. If the
labour market continues to improve in line with our expectations, we believe the Fed will
look through the low level of core inflation and deliver a first rate hike in June. We
expect the pace of hikes to be slow, but not as slow as financial markets are pricing.
The FOMC will also release its updated economic projections. We expect forecasts
for growth and unemployment this year to be basically unchanged, but the forecasts for
headline and core PCE inflation to be revised down. The longer term unemployment rate
is also likely to be revised closer to 5.0% from the current 5.2-5.5%.
Important disclosures and certifications are contained from page 6 of this report.
Senior Analyst
Signe Roed-Frederiksen
+45 45128229
[email protected]
www.danskeresearch.com
FOMC preview
FOMC chart book
QE halted in October; a hike in the fed funds rate is next
Market expects pace of hiking to be very slow
Source: Federal Reserve, and Danske Bank Markets
Note: Dark (light) shading indicates periods of tightening (easing)
Source: Federal Reserve, Bloomberg and Danske Bank Markets
Core inflation running below Fed’s comfort zone...
...and is heading lower
Source: BEA and Danske Bank Markets
Note: Dark (light) shading indicates periods of tightening (easing)
Source: BEA and Danske Bank Markets
Market inflation expectations have dropped…
…but survey based measures are stable
Source: Federal Reserve of Philadelphia, Macrobond Financial, University of
Michigan and Danske Bank Markets
Note: Dark (light) shading indicates periods of tightening (easing)
Source: Federal Reserve of Philadelphia, Macrobond Financial, University of
Michigan and Danske Bank Markets
2|
16 March 2015
www.danskeresearch.com
FOMC preview
Job growth is solid
Consumers are upbeat on labour market developments
Source: BLS and Danske Bank Markets
Note: Dark (light) shading indicates periods of tightening (easing)
Source: BLS and Danske Bank Markets
Note: Dark (light) shading indicates periods of tightening (easing)
Unemployment gap is getting smaller...
...but wage inflation remains subdued
Source: BLS, CBO and Danske Bank MarketsNote: Dark (light) shading indicates
periods of tightening (easing)
Source: BLS and Danske Bank Markets
Note: Dark (light) shading indicates periods of tightening (easing)
Business confidence in line with solid growth
Consumer confidence at cycle highs
Source: ISM and Danske Bank Markets
Note: Dark (light) shading indicates periods of tightening (easing)
Source: University of Michigan, Conference Board and Danske Markets
Note: Dark (light) shading indicates periods of tightening (easing)
3|
16 March 2015
www.danskeresearch.com
FOMC preview
Personal spending has got a boost from lower oil prices...
...but February data was weak
Source: BEA, Federal Reserve of St. Louis and Danske Bank Markets
Note: Dark (light) shading indicates periods of tightening (easing)
Source: BEA, Federal Reserve of St. Louis and Danske Bank Markets
House prices have ticked higher but sales remain slow
Mortgage and corporate funding costs are still very low
Source: NAR, U.S. Census Bureau and Danske Bank Markets
Source: Moody’s, MBA, Federal Reserve, Eurostat and Danske Bank Markets
FOMC statement on January 28
Information received since the Federal Open Market Committee met in December
suggests that economic activity has been expanding at a solid pace. Labor market
conditions have improved further, with strong job gains and a lower unemployment rate.
On balance, a range of labor market indicators suggests that underutilization of
labor resources continues to diminish. Household spending is rising moderately; recent
declines in energy prices have boosted household purchasing power. Business fixed
investment is advancing, while the recovery in the housing sector remains slow. Inflation
has declined further below the Committee’s longer-run objective, largely reflecting
declines in energy prices. Market-based measures of inflation compensation have
declined substantially in recent months; survey-based measures of longer-term
inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum
employment and price stability. The Committee expects that, with appropriate policy
accommodation, economic activity will expand at a moderate pace, with labor market
indicators continuing to move toward levels the Committee judges consistent with its dual
4|
16 March 2015
www.danskeresearch.com
FOMC preview
mandate. The Committee continues to see the risks to the outlook for economic
activity and the labor market as nearly balanced. Inflation is anticipated to decline
further in the near term, but the Committee expects inflation to rise gradually toward
2 percent over the medium term as the labor market improves further and the
transitory effects of lower energy prices and other factors dissipate. The Committee
continues to monitor inflation developments closely.
To support continued progress toward maximum employment and price stability, the
Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the
federal funds rate remains appropriate. In determining how long to maintain this target
range, the Committee will assess progress--both realized and expected--toward its
objectives of maximum employment and 2 percent inflation. This assessment will take
into account a wide range of information, including measures of labor market conditions,
indicators of inflation pressures and inflation expectations, and readings on financial and
international developments. Based on its current assessment, the Committee judges
that it can be patient in beginning to normalize the stance of monetary policy.
However, if incoming information indicates faster progress toward the Committee’s
employment and inflation objectives than the Committee now expects, then increases in
the target range for the federal funds rate are likely to occur sooner than currently
anticipated. Conversely, if progress proves slower than expected, then increases in the
target range are likely to occur later than currently anticipated.
The Committee is maintaining its existing policy of reinvesting principal payments from
its holdings of agency debt and agency mortgage-backed securities in agency mortgagebacked securities and of rolling over maturing Treasury securities at auction. This policy,
by keeping the Committee’s holdings of longer-term securities at sizable levels, should
help maintain accommodative financial conditions.
When the Committee decides to begin to remove policy accommodation, it will take a
balanced approach consistent with its longer-run goals of maximum employment and
inflation of 2 percent. The Committee currently anticipates that, even after employment
and inflation are near mandate-consistent levels, economic conditions may, for some
time, warrant keeping the target federal funds rate below levels the Committee views as
normal in the longer run.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C.
Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Jeffrey M.
Lacker; Dennis P. Lockhart; Jerome H. Powell; Daniel K. Tarullo; and John C. Williams.
5|
16 March 2015
www.danskeresearch.com
FOMC preview
Disclosures
This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske
Bank’). The author of the research report is Signe Roed-Frederiksen, Senior Analyst.
Analyst certification
Each research analyst responsible for the content of this research report certifies that the views expressed in the
research report accurately reflect the research analyst’s personal view about the financial instruments and issuers
covered by the research report. Each responsible research analyst further certifies that no part of the compensation
of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed
in the research report.
Regulation
Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject
to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske
Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority
(UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation
Authority are available from Danske Bank on request.
The research reports of Danske Bank are prepared in accordance with the Danish Society of Financial Analysts’
rules of ethics and the recommendations of the Danish Securities Dealers Association.
Conflicts of interest
Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of highquality research based on research objectivity and independence. These procedures are documented in Danske
Bank’s research policies. Employees within Danske Bank’s Research Departments have been instructed that any
request that might impair the objectivity and independence of research shall be referred to Research Management
and the Compliance Department. Danske Bank’s Research Departments are organised independently from and do
not report to other business areas within Danske Bank.
Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes
investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate
finance or debt capital transactions.
Financial models and/or methodology used in this research report
Calculations and presentations in this research report are based on standard econometric tools and methodology
as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be
obtained from the authors on request.
Risk warning
Major risks connected with recommendations or opinions in this research report, including a sensitivity analysis
of relevant assumptions, are stated throughout the text.
Date of first publication
See the front page of this research report for the date of first publication.
General disclaimer
This research has been prepared by Danske Bank Markets (a division of Danske Bank A/S). It is provided for
informational purposes only. It does not constitute or form part of, and shall under no circumstances be
considered as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments
(i.e. financial instruments mentioned herein or other financial instruments of any issuer mentioned herein and/or
options, warrants, rights or other interests with respect to any such financial instruments) (‘Relevant Financial
Instruments’).
The research report has been prepared independently and solely on the basis of publicly available information that
Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not
untrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates
and subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation
any loss of profits, arising from reliance on this research report.
The opinions expressed herein are the opinions of the research analysts responsible for the research report and
reflect their judgement as of the date hereof. These opinions are subject to change, and Danske Bank does not
undertake to notify any recipient of this research report of any such change nor of any other changes related to the
information provided in this research report.
6|
16 March 2015
www.danskeresearch.com
FOMC preview
This research report is not intended for retail customers in the United Kingdom or the United States.
This research report is protected by copyright and is intended solely for the designated addressee. It may not be
reproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank’s prior
written consent.
Disclaimer related to distribution in the United States
This research report is distributed in the United States by Danske Markets Inc., a U.S. registered broker-dealer
and subsidiary of Danske Bank, pursuant to SEC Rule 15a-6 and related interpretations issued by the U.S.
Securities and Exchange Commission. The research report is intended for distribution in the United States solely
to ‘U.S. institutional investors’ as defined in SEC Rule 15a-6. Danske Markets Inc. accepts responsibility for this
research report in connection with distribution in the United States solely to ‘U.S. institutional investors’.
Danske Bank is not subject to U.S. rules with regard to the preparation of research reports and the independence
of research analysts. In addition, the research analysts of Danske Bank who have prepared this research report are
not registered or qualified as research analysts with the NYSE or FINRA but satisfy the applicable requirements
of a non-U.S. jurisdiction.
Any U.S. investor recipient of this research report who wishes to purchase or sell any Relevant Financial
Instrument may do so only by contacting Danske Markets Inc. directly and should be aware that investing in nonU.S. financial instruments may entail certain risks. Financial instruments of non-U.S. issuers may not be
registered with the U.S. Securities and Exchange Commission and may not be subject to the reporting and
auditing standards of the U.S. Securities and Exchange Commission.
7|
16 March 2015
www.danskeresearch.com