March FOMC Meeting

The markets' focus this week will be on whether the FOMC responds in any way to the recent market volatility and growth/inflation concerns.  There are a number of ways it can.  But, it is also conceivable the FOMC won't do anything, particularly since the markets appeared to begin stabilizing last week.  The markets may very well quickly shift their focus back to evidence on the extent to which economic growth is speeding up in response to re-openings and fiscal stimulus once the Meeting is out of the way.  This week's US economic data, indeed, risk dampening these expectations.

The FOMC could decide to respond to the recent market concerns by changing policy.  It could decide to increase purchases of longer-term Treasuries, just like the ECB did last week.  Or, it could do an operation twist, lifting short-term rates as well as increasing longer-term purchases.  

There is a potential problem with increasing purchases of longer-term Treasuries, however.  The additional monetary stimulus could exacerbate the growth/inflation fears in the Treasury market.  So, the increased purchases could backfire and result in higher yields.  An operation twist would presumably prevent this problem.  But, it's not clear the Fed would move now to tighten the short-end of the curve, as current core inflation remains soft. 

Instead of a policy change, the Fed could tweak the FOMC Statement to promise a quick response to future inflation, if needed.  This could be done in the Statement or by Fed Chair Powell in his post-meeting news conference.  The prior meeting's Statement said:

 "The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments." 

Theses sentences would seem to cover the possibility the Fed would respond quickly to an unwanted speedup in inflation.  But, it could be tweaked to increase emphasis on a response to inflation pressures.  Also, the sentences appear in the last paragraph of the Statement.  It could be moved to a more prominent position, but that could be construed as a more aggressive signal than officials want to send.

The markets will also likely pay attention to updates to the Fed's Central Tendency forecasts.  The Treasury market could react negatively if officials boost the growth/inflation outlook without changing the expected Fed Funds Rate trajectory.  But, this reaction could be muted if Powell emphasizes downside risks to the outlook or if the growth speedup is seen as temporary, as is likely. 

The Fed's Central Tendencies will likely show a much stronger Real GDP trajectory, particularly for 2021, as the new fiscal stimulus is built in.  But, Powell is still likely to emphasize downside risks to the outlook stemming from the virus and its more-contagious strains, as did the Fed staff at the January FOMC Meeting.  As a result, the Central Tendencies could show a 2021 speedup in GDP Growth followed by more subdued growth in the following few  years.  The Central Tendency for Inflation will probably be little changed, as it already built in a modest speedup over the 2021-23 period.  For 2021, the PCE Deflator is expected to be up 1.7-1.8% (Q4/Q4).  In January, it was up 1.5% (y/y).  The combination of only a temporary speedup in GDP Growth and modest acceleration in inflation could temper market concerns of an overly easy monetary policy.

This week's US economic data could temper near-term growth expectations.  February Retail Sales, both Total and Ex Auto, are seen falling by 0.5% m/m.  The risk is to the downside.  Besides the drag from bad weather, particularly in Texas, a pullback often follows a strong advance such as January's.  Note, though, that the best measure of Retail Sales will be Ex Auto/Ex Gasoline.  Gasoline Sales will reflect higher prices.  There is downside risk to the consensus estimate of +0.6% m/m in February Industrial Production.  Chips shortages were still curtailing motor vehicle production that month.  Also, Total Hours Worked in Manufacturing fell 0.3-0.4% m/m.  Consensus looks for little change in February Housing Starts and a decline in Permits.  Bad weather represents downside risk to this forecast.