Fed expected to leave policy unchanged at this week’s meeting but raise rates at the next meeting
U.S. manufacturing confidence expected to remain strong despite today’s expected ISM drop
Italy appears to be headed back to elections
Trump administration averts EU trade war for the time being with a 30-day extension
Fed expected to leave policy unchanged at this week’s meeting but raise rates at the next meeting — The FOMC at its 2-day meeting that begins today will almost certainly leave its policy unchanged since the FOMC just raised rates at its last meeting on March 20-21. The market is discounting only a 35% chance of a rate hike this week.
However, the market is discounting the chances at 100% for another +25 bp rate hike at the FOMC’s next meeting on June 12-13. The market is then fully discounting the Fed’s third rate hike of the year by its Sep 25-26 meeting. The market is currently discounting the odds for a fourth rate hike of the year at the Dec 18-19 meeting at only about 50%.
If the Fed proceeds with its Fed-dot forecast for two more rate hikes this year (adding to the one rate hike already seen), then the funds rate will be at 2.00-2.25% by year-end. This would put the funds rate above the Fed’s 2.0% inflation target and push the real fed funds rate into positive territory for the first time in more than a decade. Once the Fed has done away with a negative real funds rate, then the Fed can raise interest rates on a slower trajectory. Indeed, the market is currently discounting only 43.5 bp of rate hikes in 2019, representing 1.7 rate hikes, according to the pricing on the Dec 2019 federal funds futures contract.
There will be no Powell press conference following this week’s FOMC meeting. Also, the Fed this week will not provide updated macroeconomic forecasts nor Fed-dot forecasts for the funds rate.
U.S. manufacturing confidence expected to remain strong despite today’s expected ISM drop — The market consensus is that today’s Apr ISM manufacturing index will show a -0.9 point decline to 58.4, adding to March’s -1.5 point decline to 59.3. However, even if today’s ISM index shows the expected decline to 58.4, the index will still be in strong shape at only -2.4 points below the 13-3/4 year high of 60.8 posted in February.
U.S. manufacturing confidence likely fell in Feb/March because of the stock market correction and trade tensions caused by President Trump’s imposition of steel-aluminum tariffs and his threat to impose tariffs on up to $150 billion of Chinese imports. The markets will be watching today’s ISM prices-paid sub-index to gauge the impact that manufacturing executives are seeing from higher input costs from higher tariff-induced steel and aluminum prices and from a rise in commodity prices in general, including energy. Aluminum prices have also seen particular strength from U.S. sanctions on Russia’s Rusal, the world’s second largest aluminum producer. The ISM prices-paid sub-index has soared by nearly 20 points in the past four months to post a new 7-year high of 78.1 in March.
Meanwhile, the ISM manufacturing new orders sub-index in March remained strong at 61.9, which was only 5.5 points below Dec’s 14-year high of 67.4. Manufacturing orders should remain in generally good shape due to (1) stronger business investment tied in part to the Jan 1 tax cuts, and (2) strong U.S. export demand with the generally weak dollar and decent overseas economic growth.
The consensus is that today’s final-April Markit U.S. manufacturing PMI will be unrevised from the preliminary-April level of 56.5. That would leave the index up by +0.9 points from March. The preliminary-April Markit U.S. manufacturing PMI was a positive leading indicator for today’s ISM index, although the Markit index level of 56.5 is below the ISM index of 59.3, which means the ISM index has some room to move lower.
Italy appears to be headed back to elections — Italy may be headed back to the polls by early summer or September after relations quickly broke down between Five Star and the Democratic Party, the last realistic configuration for a government. The Democratic Party is refusing to even negotiate with Five Star, preferring to remain in opposition or go to new elections. Five Star already failed to cajole the center-right coalition into forming a government.
Five Star leader Luigi Di Maio on Monday said that “At this stage there is no solution other than returning to elections as soon as possible.” The decision will be up to Italian president Mattarella about whether to try some last-ditch effort to form a government or to simply call new elections. It is not clear whether elections could be held as soon as June or would have to be delayed until September.
The Italian 10-year bond yield on Monday rose by +5.6 bp to 122.6 bp on the political deadlock and the possibility of new elections. Still, the Italian 10-year yield remains subdued in general at only 9.0 bp above last week’s 1-3/4 year low of 113.6 bp.
Trump administration averts EU trade war for the time being with a 30-day extension — The Trump administration last night extended the steel-aluminum tariff exemptions for the EU, Canada and Mexico by 30 days until June 1. That will give the Trump administration more time to try to wring trade concessions out of Europe and NAFTA concessions out of Canada and Mexico. However, the markets will still need to worry about the very real possibility that the tariffs on EU steel-aluminum will go into effect on June 1, which would certainly cause the EU to retaliate with 25% tariffs of $3.5 billion worth of U.S. goods. In some other positive news for the markets, the Trump administration said that it reached agreements in principle with Australia, Argentina and Brazil for permanent exemptions from the U.S. steel-aluminum tariffs. An agreement was earlier reached with South Korea. The U.S. steel-aluminum tariffs have already gone into effect against Russia, China and Japan.
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