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The Fed may have a hard time overlooking the economy's recent flop

Aug 25, 2024, 15:39 IST

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Federal Reserve Board Chair Janet Yellen testifies before a Senate Banking, Housing and Urban Affairs Committee hearing on the "Semiannual Monetary Policy Report to Congress" in Capitol Hill, Washington February 11, 2016The Federal Reserve will release a statement on its latest policy decision and opinions on the economy on Wednesday.

In company with leaving its benchmark interest rate unchanged, economists don't expect the Fed to make other major changes.

But the way it appraises the economy could present a challenge: acknowledging temporary drags in the first quarter without suggesting that it plans to raise rates faster than expected.

"Given the data-dependency of monetary policy, it is important for the FOMC to describe the economic status in a way that it can manage market expectations," said Lewis Alexander, Nomura's chief economist, in a note.

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"The weaker-than-expected March employment report and core CPI might demand further elaboration regarding the committee's intentions to overlook weak Q1 data," he added.

Depending on who's interpreting the economic data, the Fed has compelling reasons to either wait or proceed with tightening monetary policy.

Those citing reasons to wait can point to last week Friday, when the Bureau of Economic Analysis said first-quarter gross domestic product rose by 0.7%, the slowest pace since the first quarter of 2014 when the economy shrank.

Because of seasonal-adjustment glitches at the BEA, first-quarter growth typically undershoots the growth trend seen in other quarters. However, weak consumer spending and the uncommon 449% year-on-year spike in mining investment has economists like David Rosenberg wondering whether the economy has entered a soft patch, adjustment issues aside.

It's "hardly likely" that the Q1 real GDP slowdown was a one-off, the Gluskin Sheff chief economist wrote in a client note. The Fed may cite seasonality again as a reason why growth slowed, just like minutes of its March meeting did.

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During its two-day meeting this week, the Fed would also have noted that inflation slipped in March one month after rising to its 2% target for the first time in five years. Personal consumption expenditures rose 1.8%, BEA data showed on Monday.

The June 13-14 meeting is when many in markets anticipate the Fed will raise borrowing costs again; Bloomberg's World Interest Rate Probability on Tuesday reflected a 70.4% chance of a rate hike next month. The Fed can look to the labor market's relative strength, even after a weaker-than-expected jobs report in March, as evidence that it can continue to hike.

"The risk, albeit a small one, is that they will come closer to moving in a tightening direction than currently expected," said Peter Hooper, Deutsche Bank's chief economist, in a preview of Wednesday's statement.

The Fed is also unlikely to provide any major updates on how it plans to stop expanding or shrink its nearly $5 trillion balance sheet as soon as this year, according to Bank of America Merrill Lynch. "Clearly the Fed does not want to surprise the market, preferring to dribble out details, thereby allowing the Fed to test the market reaction," US Economist Michelle Meyer said in a note.

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