The Federal Reserve’s long-awaited 2-day March monetary policy meeting kicks off today, and frankly, it couldn’t come at a more interesting time.
As we all know, the Federal Reserve has a dual mandate to promote full employment and stable prices, and on those fronts, the central bank has been broadly successful. The U.S. labor market appears to have turned a corner, with monthly non-farm payrolls growing at an average rate of nearly 300k jobs per month over the last quarter. While headline inflation has lagged the Fed’s 2% target, the central bank has repeatedly chalked that up to the temporary impact of falling oil prices.
So what’s the rub?
For the Federal Reserve, the problem is not its dual mandate—it’s everything else. Both employment and inflation are lagging economic indicators, and the more current measures of economic activity have turned sharply lower over the last few months. Citigroup’s U.S. Economic Surprise Index, which measures how economic data performs relative to analyst expectations, has quietly dropped to its lowest level since mid-2012; more saliently, we’ve seen massive disappointments in Retail Sales, PPI, Consumer Sentiment, Capacity Utilization, Industrial Production, and now Building Permits just in the last week alone.
Strong buck = Tough luck for U.S. multinationals
Beyond the recent disappointments in coincident and leading economic indicators (or perhaps partly related to them), the recent strength in the dollar has created another source of concern for the central bank. The strong dollar was a major driver in the weak results from Q4 corporate earnings season, while FiREapps noted that over 25% of the companies it follows cited the negative currency impact on profits (vs. a recent average of just 6.4%), with two-thirds of those companies anticipating further difficulties with the strong dollar throughout this year. In some ways, the recent strength in the dollar is doing much of the Fed’s heavy lifting already. The rise in the currency decreases the costs of imports and makes U.S. exports less attractive internationally, theoretically tapping the brakes on the economic recovery and inflation.
How now, Fed?
In her semi-annual Humphrey-Hawkins testimony, Fed Chair Janet Yellen stated that the central bank would remove its pledge to be “patient” before raising interest rates, before…well, before raising interest rates. Notwithstanding the recent downturn in other economic indicators and strength in the dollar, we still feel that the Fed is likely to remove its “patient” wording to increase its flexibility heading into this summer. Beyond that nod to the bulls though, the central bank may up its rhetoric around the recent strength in the U.S. dollar, potentially offsetting any dollar-bullish impact of “losing patience.”
As the big rally in the dollar month-to-date shows, expectations for a hawkish Fed are clearly elevated, and anything less than a 100% optimistic statement may disappoint some buck bulls, setting the stage for a potential “buy the rumor, sell the news” reaction in the greenback. That said, if the central bank sounds upbeat on the economy and downplays the impact of the recent dollar strength, the potential for a June rate hike will remain on the table and the recent dollar uptrend could turn parabolic.