FOMC Preview: Ignore the noise or ignore the signal? – Rabobank

Philip Marey Senior US Strategist at Rabobank, suggests that at 0.7% Q1 GDP growth was somewhat weaker than expected by the market consensus (1.0%), but not as bad as the 0.2% nowcast published by the Atlanta Fed and personal consumption growth was particularly slow, but business and residential investment accelerated.

Key Quotes

“Government spending and inventories were also a drag on growth, while the effect of net exports was negligible. Note that despite efforts by the BEA last summer, there is still considerable residual seasonality in US GDP data. This means that ‘true’ GDP growth is probably larger than the official 0.7% figure. This is why Yellen called GDP a noisy indicator. Therefore, the Fed is likely to ignore this weak GDP figure and continue to aim for June. Then there is also the weather possibly playing a role in the slowdown in personal consumption growth. However, the weather does not explain the weak March nonfarm payroll growth figure published earlier this month, as there was only a modest increase in people with a job not showing up for work due to bad weather between February and March. Therefore, the weak economic data are not all noise, there may actually be some signals that should not be ignored.”

“Noise…

The FOMC meets on May 2 and 3, and concludes with a formal statement. There will be no press conference by Chair Yellen, nor an update of the economic and rate projections. Since the Fed is attributing the disappointing economic data to noise, they are likely to continue to aim for a hike in June. In fact, the Fed remains optimistic. They continue to emphasize the upward risk to the outlook from fiscal policy. The March dot plot implied three rate hikes of 25 bps each this year (including the March hike) and more recently – even after the sinking of the health care bill – several Fed speakers have repeated that they anticipate to hike three times this year, and even hinted at the possibility of four hikes depending on the economic data. The Fed is also banking on the upbeat confidence indices and elevated stock prices. Meanwhile, the possible repercussions of the new administration’s trade policies do not seem to affect the Fed’s economic.”

“… or signal?

However, if they are overlooking the signals behind the noise 2017 may turn out to be another disappointing year for the Fed. While the weak GDP growth figure for Q1 could be explained by residual seasonality, the employment growth slowdown in March cannot be attributed to the weather. This suggests that the disappointing economic data are not just noise, but they may be giving signals that the US economy is losing momentum. And if we are right in our assessment that the stock market rally is overdone and that it will be difficult for President Trump to deliver on his promises, then the Fed joining the party could make the bubble even more dangerous, ending in an even larger reversal.

We expect fiscal policy to disappoint in terms of timing, size and impact on the economy. The health care bill debacle underlines this risk. What’s more, we see considerable downside risk to US economic growth in case of protectionist measures by the US (including any form of border adjustment in the new tax plan) and its trading partners. In addition, there are overseas risks to the US economy such as weak global growth – which would be amplified by protectionism –, the Chinese economy and developments in Europe. Finally, geopolitical risk has risen in recent weeks, most notably in relation to North Korea and Syria. All’n all, we continue to have our doubts about the Fed’s plans to hike three times this year. For 2017 as a whole, we expect two (with the second in December) instead of three hikes. Of course, with substantial upside risk to our baseline if it’s only noise.”