What Might Keep the Fed on Hold

While the FOMC Minutes suggested the odds are high that the Fed will either hike or signal an upcoming hike at the March 14-15 FOMC meeting, it is not a slam dunk that it will.  Some of the key US economic data scheduled over the next couple of weeks risk softening a bit, although likely remaining strong enough to support a tightening.  Conversely, some of the high inflation prints should be discounted as temporary.  But, uncertainty surrounding international developments, particularly the triggering of Article 50 to formally begin the process of Brexit and the French Presidential elections, could put the Fed on pause as risk management considerations behoove it to wait to see the market impacts.

The market impacts of these international developments may not be fully known until after the May 2-3 FOMC meeting.  UK Prime Minister May said Article 50 would be triggered by the end of March.  The first round of the French elections is on April 23 and the second round on May 7.  The fear is that the election outcome could move the EU a step further to a breakup.  As a result, the Fed might wait until the June FOMC meeting to decide whether to tighten.

Market behavior could determine the amount of significance the Fed places on a risk management approach to monetary policy.  A sharp drop in the euro and/or pound, along with a flight-to-safety rally in Treasuries, could be the needed signal that the probability of a EU breakup has risen to a level that should make Fed officials think twice about the desirability of hiking rates.  But, such market moves are not likely until the feared French election outcome looks to be a strong possibility -- the window being between the first and second rounds of the election.  So, this market signal will not likely be seen at the March FOMC Meeting but could be relevant at the May meeting.  And, Fed officials may have to weigh risk management considerations without clear market signals at the March FOMC meeting.

US economic data to be released over the next two weeks will be weighed at the March meeting.  The February Mfg ISM, due March 1, is one important statistic.   Consensus is for an uptick to 56.3 from the already high 56.0 January level.  But, the most reliable evidence, the Markit Mfg PMI (correctly predicting direction in each of the past 6 months) points to a decline.  Another piece of negative evidence is that  this year's seasonal factors subtract 0.2 pt more from the January-February m/m change in the Mfg ISM than last year's seasonals.  Note that today's release of January Durable Goods Orders showed soft internals, as Orders Excluding Transportation and Capital Goods Orders Excluding Civilian Aircraft both slipped.  To be sure, the Mfg ISM would have to fall below 53.0 -- the high end of the range seen before last December, however, to raise any serious concern about economic growth. 

The January Core PCE Deflator is another important statistic due next week.  Consensus is for a slight speedup to +0.2% m/m from +0.1% in December.  But, like the CPI, which much of the PCE Deflator is derived from, temporary factors are behind the speedup.   These factors include a bounce-back from heavy discounting of apparel in the holiday  season, start-of-year price hikes, and a pass-through of higher oil prices to items such as airfares.  So, a high print should be discounted.