Morning comment: Fed on hold, BoE to follow suit

Chris Scicluna
Emily Nicol
Mantas Vanagas

Overview:
There were no major surprises from yesterday’s Fed announcements, with the FOMC leaving the federal funds rate target range unchanged at 2.25-2.50%. While the Board of Governors cut the rate paid on required and excess reserves by 5bps to 2.35%, that move should be considered merely a technical adjustment to keep the effective FFR – which had touched in 2.45% in recent days – where the FOMC wants it to be. And much of the FOMC statement was unchanged from March, including the comment that the Fed will be patient as it determines the next move in rates. The economic assessment noted that overall and core inflation “have declined and are running below 2 percent”, and so Chair Powell’s press conference saw plenty attention on what this might mean for policy. But he thought that inflation might recently have been restrained by temporary factors, and the clear message was that the FOMC is now very much on hold, with no strong case for a move in the FFR in either direction. See the comment from Daiwa America’s Mike Moran for further analysis. 

With Powell resisting the temptation for more dovishness, US stocks retreated late in the day, leaving the S&P down 0.75% while earlier gains in USTs were reversed leaving, e.g., 10Y yields back at 2.50% at the close. And the Fed also gave the dollar a ½ppt boost too, e.g. pushing the euro down to $1.12 and the yen to 111.5/$. In Asia today, however, among those markets that were open, the Hang Seng (currently up 0.6%) and Korean KOSPI (up 0.4%) made gains following a report on CNBC that the US and China could announce a trade deal as soon as next Friday. 

Moving to Europe, after German retail sales figures released this morning added to evidence of a return to positive growth in the euro area’s largest member state in Q1, the focus will shift to the BoE, whose lunchtime announcements will see rates left unchanged but possibly a slightly more hawkish tone adopted in response to its updated economic forecasts.

UK:
The main policy event today will be the announcement by the BoE of its latest monetary policy decision and publication of its May Inflation Report. We expect no changes to policy, with Bank Rate set to be left at 0.75%. The MPC’s forward guidance is also likely to remain little changed, continuing to suggest that monetary policy tightening will be required if the economy evolves in line with the BoE expectations. In the last Inflation Report, conditioned on slightly less than two full 25bp increases in Bank Rate over the forecast horizon, the BoE expected that inflation will eventually settle slightly above its 2% target. Since then, in line with the global trend, market expectations for monetary policy have shifted downwards. And so the new set of projections should be based on barely more than one rate hike over the horizon, which will probably leave the MPC’s CPI forecast above-target in coming years. This suggests that the tone of MPC communication – and Governor Carney’s press conference – might be slightly on the hawkish side in order to try to align market expectations with its own thinking.

In terms of the outlook for growth, in March the MPC acknowledged that the economic dataflow had been mixed, but also revised up its Q1 GDP forecast to 0.3%Q/Q. We are slightly less optimistic about the pace of expansion last quarter. However, with aforementioned stockpiling ahead of a possible no-deal Brexit having boosted activity, a reading in line with BoE expectations is not impossible. Of course, the MPC’s assessment of the economic effects of Brexit uncertainty will be in the limelight too. Having previously conditioned its projections on the assumption of a smooth adjustment to the average of a range of possible outcomes, given the extension to Article 50 until the end of October, the MPC might provide a bit more colour on how the Brexit process is expected to affect the economy in coming quarters. 

On the data front, after yesterday’s disappointing manufacturing PMI saw the headline index fall 2pts to 53.1 in April, the only UK release of note today will be the equivalent construction PMI. Having dipped into contractionary territory in February and March, the headline PMI might inch back above 50. However, the survey will most likely reaffirm that construction sector momentum remained subdued at the start of Q2. Meanwhile, with UK political dysfunction continuing, today’s the results of today’s local elections in many parts of the country are likely to heap further pressure on Theresa May as she continues to weigh up what, if any, concessions to offer the Labour party in her ongoing Brexit negotiations.

Euro area:
With regional markets having reopened this morning after yesterday’s national holidays, the final manufacturing PMIs for April from the euro area and various member states are due today. The flash estimates saw modest increases in the headline figures for the euro area (47.8) and Germany (44.5), while France posted a modest drop (to 49.6), suggesting ongoing weakness in the sector at the start of Q2. April’s Italian and Spanish PMIs, published for the first time today, will also likely point to a modest improvement last month. 

While flash estimates of Q1 GDP were published by many member states earlier this week, the first estimates from Germany will not be published until 15 May. And so, attention this morning was on the latest German retail sales figures for March, for further insight into the pace of recovery at the start of the year. Admittedly, these reported a decline at the end of the first quarter, by 0.2%M/M and 2.1%Y/Y – although the monthly drop was smaller than had been expected, while annual growth was distorted by the timing of the Easter holiday. Indeed, food sales were down more than 5½%Y/Y in March, while non-food sales were flat compared with a year earlier, with declining sales of clothing and pharmaceutical products offset by a jump in sales of household furnishings and appliances.

Overall, today’s weakness followed two months of solid gains at the start of the year. And so, over the first quarter as a whole, retail sales were still up 1.6% compared with Q4, the strongest pace for three quarters and the second strongest since end-2016. And combined with a surge in new car registrations last quarter (13½%Q/Q), today’s release strongly suggests a solid contribution from private consumption to German GDP growth in Q1. Indeed, consistent with the stronger outturn in euro area GDP growth in Q1 (+0.4%Q/Q), we expect GDP growth in Germany of 0.3%Q/Q, which would represent the first positive growth in three quarters.

In the markets, France will sell 10Y, 15Y and 20Y bonds.

US:
In the US, preliminary estimates for non-farm productivity and unit labour costs in Q1 will be released along with the usual weekly jobless claims numbers. The full factory orders report for March is also due after last week’s preliminary durable goods orders data surprised significantly on the upside.

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