- FOMC is braced for a slow recovery
- ECB today may raise the size of its QE program
- Another 3.5 million of initial unemployment claims expected today
- Deflator expected to start dropping sharply
- China’s PMIs stay above 50
FOMC is braced for a slow recovery — The FOMC at its policy meeting that ended yesterday left its policy unchanged, which was in line with market expectations. The FOMC did not provide any new interest rate guidance or set any parameters on its unlimited QE program. The FOMC left intact most of the important language in its post-meeting statement.
The Fed does not appear to be optimistic about a strong recovery any time soon. The post-meeting statement said, “The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near-term and poses considerable risks to the economic outlook over the medium term.”
In his post-meeting press conference, Fed Chair Powell added, “Economic activity will likely drop at an unprecedented rate in the second quarter. It may well be the case that the economy will need more support from all of us, if the recovery is to be a robust one.” He encouraged more fiscal action by Congress and said that now is not the time to worry about the federal debt.
The markets showed little reaction to the outcome of the FOMC meeting. The 10-year T-note yield rose by +1.4 bp to 0.627%, but remained within its very narrow 2-week range. The federal funds futures curve turned slightly more dovish by 1-3 bp depending on the futures month. The market is expecting the Fed to leave its funds rate target unchanged for at least the next two years, with only a 22% chance of a rate hike by late 2022, according to the federal funds futures market.
ECB today may raise the size of its QE program — The ECB at its policy meeting today is expected to leave its key interest rates unchanged, but the ECB might expand the size of its Pandemic Emergency Purchase Program by 250 billion euros or even 500 billion euros from its current size of 750 billion euros. An ECB hike in the size of its Pandemic QE program would help to calm the market’s nerves by making clear that the ECB intends to continue its aggressive QE buying and will keep buying Italian debt.
The ECB since the end of February has boosted its balance sheet by 655 billion euros (+14%) to a record 5.35 trillion euros. While impressive, the ECB’s securities purchases pale in comparison to the Fed, which has boosted its balance sheet by $2.4 trillion (+58%) since the end of February to a record $6.57 trillion.
The ECB’s main problem right now is that it is the only firefighter on the scene since EU leaders have been unable to agree as yet on a big fiscal rescue plan. EU leaders are scheduled to meet again next Wednesday for another try. Germany refuses to mutualize debt to finance a rescue package, although Germany is willing to allow countries such as Italy to borrow from the ESM bailout mechanism without major restrictions.
While EU leaders squabble over a fiscal rescue package, the ECB is being forced to prevent a sovereign debt crisis from developing in Italy and to a lesser degree in Spain. There was bad news on Wednesday when Fitch unexpectedly downgraded Italy’s debt rating by a notch to one notch above junk. The ECB will keep buying Italy’s debt even if it falls into junk status, but there are a host of bond indexes and investors that would be under pressure to dump Italy’s bonds if Italy’s debt rating falls into junk status.
The spread of the Italian 10-year bond yield over the bund yield on Wednesday rose by +5 bp to 225 bp due to Fitch’s Italian downgrade. However, the spread remains comfortably below March’s 11-month high of 279 bp.
The ECB today might address the country-level proportions of its QE program, which are referred to as the capital keys. The ECB in the past has bought the securities of each Eurozone nation in roughly the proportion to its size in the Eurozone. However, the ECB dropped that restriction in its Pandemic QE program and has been buying a large amount of Italian securities to prevent Italy’s bond market from blowing up. The ECB plans to eventually shift its portfolio back to meet its capital keys. However, the ECB needs to make it clear to the markets that the convergence to the capital keys will not happen this year and perhaps not even next year, or else the markets will start to worry that the ECB will have to lighten up on its Italian bond purchases.
Another 3.5 million of initial unemployment claims expected today — The consensus is that another 3.5 million people filed for unemployment benefits in the week ended last Friday (Apr 24). That would be down from the 4-6 million figures seen in the previous four weeks but still about 17 times the normal level of claims. A total of 26.7 million people have filed for unemployment benefits since early March, which constitutes about 17% of the household-survey labor force of 155.8 million. Unless the U.S. economy reopens soon, the U.S. unemployment rate could exceed 20% for at least a month or two. The unemployment rate in this cycle will easily exceed the current post-war record of 10.8% posted in 1982.
Deflator expected to start dropping sharply — The consensus is for today’s March PCE deflator to drop to +1.3% y/y from Feb’s +1.8% y/y and core PCE deflator to drop to +1.6% y/y from Feb’s +1.8%. The deflator will drop farther in April when spot oil prices plunged to negative levels and the U.S. economy was in a partial shutdown mode. The 10-year breakeven inflation expectations rate is currently at +1.13%, which is far below the Fed’s inflation target of 2.0%.
China’s PMIs stay above 50 — China’s April mfg PMI last night fell -1.2 to 50.8, weaker than the consensus of -1.0, but still above 50. The April non-mfg PMI rose +0.9 to 53.2, stronger than expectations of +0.2.