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  • FOMC minutes could hint at whether rate-pause is only temporary
  • US/Chinese trade talks resume as Trump says nothing “magical” about March 1 deadline
  • PM May expects “significant” meeting today with Juncker
 

FOMC minutes could hint at whether rate-pause is only temporary — Today’s release of the minutes from the Jan 29-30 FOMC meeting will be watched to see if all the FOMC members were on board with the shift to a fully-neutral policy.  The question is whether FOMC members believe that their rate-hike cycle is over, or whether they expect to resume the rate hikes when the coast is clear.

The federal funds futures market shows that the market is expecting no funds rate changes in 2019 and a 68% chance of a 25 bp rate cut in 2020.  The current funds rate of 2.40% (target range of 2.25%/2.50%) is still 35 bp below the Fed’s median view of a long-term neutral funds rate of 2.75%, suggesting that the Fed still has another 25-50 bp of rate hikes to go. 

The FOMC in January’s post-meeting statement dropped its reference to the need for “some further gradual increases” in interest rates and adopted the phrase, “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support” its statutory mandate.

The FOMC in its post-meeting statement also dropped its reference to “balanced risks,” which suggests that the Fed is not sure whether the risks are now pointed to the downside.  However, the Fed sought to provide some reassurance on the economy by saying that the Committee continues to view “sustained expansion of economic activity” as the most likely outcome. 

The FOMC also made surprisingly dovish statements about the balance sheet, saying that is “prepared to adjust any details for completing balance sheet normalization in light of economic and financial developments.”  Fed Chair Powell said in his press conference that the normalization process will be completed “sooner and with a larger balance sheet” than previous estimates.  The Fed said that it will continue to run monetary policy with a floor-type system, which requires a much larger amount of reserves than a corridor system.  A recent survey of government securities dealers by the NY Fed found a consensus that the Fed will end its balance sheet reduction program at $3.5 trillion, which implies the program could end by early 2020.

While the Fed’s move in January to a fully neutral policy was a dovish short-term move, we believe that the Fed will still try to raise the funds rate by another +50 bp to 2.75%/3.00% as soon as global risks and macroeconomic conditions allow.  The current funds rate level of 2.40% is only 0.40% above the Fed’s 2.0% inflation target, which means the real federal funds rate is still abnormally low relative to the Fed’s inflation target.  Since 1971, the real federal funds rate (compared with the core PCE deflator) has averaged a much higher 1.80%.  If and when the global and U.S. economies regain their balance and financial and geopolitical risks dissipate, we have little doubt that the Fed will quickly reassert its intent to raise interest rates by two more notches to 2.75%-3.00%.  The new set of Fed dots at the next FOMC meeting on March 19-20 will show whether Fed members really believe the Fed is done tightening.

 

 

US/Chinese trade talks resume as Trump says nothing “magical” about March 1 deadline — The markets were encouraged by President Trump’s comment on Tuesday that the US/Chinese trade talks are “very complex,” that the talks are “going well,” and the March 1 deadline is not “a magical date.”  Mr. Trump’s comments continued to suggest that Mr. Trump might be willing to extend next Friday’s deadline if the talks are going well and if there is a chance for a deal.  Bloomberg reported last week that President Trump is considering a 60-day extension of the March 1 deadline.

An extension is likely to be needed considering that White House Council of Economic Advisors Chairman Hassett on Tuesday was the latest administration official to say that there’s still a lot of ground left to cover for an agreement.

Deputy-level U.S. and Chinese officials today will hold their second day of talks in Washington.  Principal-level talks will then be held on Thursday and Friday led by USTR Lighthizer and Chinese Vice Premier Liu.

PM May expects “significant” meeting today with Juncker — Prime Minister May said she will have a “significant” meeting with European Commission President Juncker in Brussels today, which sparked a +1.07% rally in GBP/USD on Tuesday to a 2-week high on hopes for progress.  However, Mr. Juncker on Tuesday said he didn’t know what Ms. May wants to propose and said that any breakthrough was unlikely. Ms. May’s government is expected to propose revised Irish border backstop language that would put some type of time constraint on the backstop, which might be enough to get Parliament to approve the plan.  However, EU officials all continue to say that the Brexit separation agreement will not be reopened to allow for changes to the backstop.

Ms. May has only a week left to come up with a solution before next Wednesday when Parliament is scheduled to vote again on Brexit.  If there is no new Brexit plan by next Tuesday, then Parliament next Wednesday might approve the Cooper-Boles amendment, which provides for an extension of the March 29 Brexit date if Parliament cannot approve a Brexit separation agreement by March 13.  The betting odds for a no-deal Brexit by April 1 remain unchanged at 7/4 (37% probability), according to oddschecker.com.  The most likely outcome at this point is that Ms. May will not be able to push a Brexit separation agreement through Parliament and will be forced to request a deadline extension to prevent a disastrous no-deal Brexit on March 29.

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