The Fed kept rates on hold yesterday – pretty much a done deal – and its statement yesterday following its two-day policy meeting was very short on new insights. But it was in line with my expectation that while the Fed would present a marginally less dovish assessment of the global economy, it would paint a still cloudy picture of the US and nurse the recently faltering rally in global risk appetite. US equities closed up 0.3% yesterday and 2, 5 and 10yr US treasury yields are down 6-10bps since Tuesday. The Fed faces seven rocky weeks ahead of its 15th June meeting. It will likely want to keep the door ajar for a hike and will therefore not want to see US yields break out of range. But the market’s violent reaction today to the BoJ’s unchanged monetary policy is also a stark reminder that an overly-hawkish Fed could derail global risk appetite and in turn delay any Fed hikes. With this in mind, my core scenario of a June is likely to be tested in coming weeks and the risk remains that flat-lining emerging market currencies will come under pressure.

1. 1
Fed pulls off 40-word Houdini
The Fed kept rates on hold yesterday – pretty much a done deal – and its statement
yesterday following its two-day policy meeting was very short on new insights.
But it was in line with my expectation that while the Fed would present a marginally less
dovish assessment of the global economy, it would paint a still cloudy picture of the US
and nurse the recently faltering rally in global risk appetite. US equities closed up 0.3%
yesterday and 2, 5 and 10yr US treasury yields are down 6-10bps since Tuesday.
The Fed faces seven rocky weeks ahead of its 15th June meeting. It will likely want to keep
the door ajar for a hike and will therefore not want to see US yields break out of range. But
the market’s violent reaction today to the BoJ’s unchanged monetary policy is also a stark
reminder that an overly-hawkish Fed could derail global risk appetite and in turn delay any
Fed hikes.
With this in mind, my core scenario of a June is likely to be tested in coming weeks and the
risk remains that flat-lining emerging market currencies will come under pressure.
40 words keep markets guessing
To say that the Fed two-page statement yesterday contained little new information would be an under-
statement. Bar the first paragraph, the statement was a copy-and-paste of the March statement, and even
then three-quarters of the wording was identical, as highlighted in yellow in Figure 1. New text was limited
to 40 words and this meagre offering contained few surprises for markets.
The basic message was that the US macro picture remains patchy – as clearly depicted in my US heat
map – but concerns about global developments have abated. The Fed introduced, or at least made more
explicit, a few new concerns as well as positives, which were broadly in line with my expectations and are
highlighted in green in Figure 1 (see It’s a Fed hiking cycle Jim, but not as we know it, 26 April 2016).
Specifically:
New negatives
 “Economic activity appears to have slowed”. Hardly a surprise, with today’s data showing that US
GDP growth collapsed in Q1 2016 to 0.5% qoq annualised from an already tepid 1.4% qoq in Q4
2015, in line with weak monthly indicators including ISM, corporate orders and goods exports.
New positives
 “labor market conditions have improved further”. A shoe-in of a statement, with the labour
participation continuing to climb and initial weekly jobless claims falling to a 42-year low.

2. 2
 “Consumer sentiment remains high”: The last time a Fed statement alluded to high consumer
sentiment was exactly a year ago, at the 29th
April 2015 policy meeting,
New neutrals
 “Household spending has moderated, although households’ real income has risen at a solid rate”:
Again more of a statement of fact than a take on the future, as retail sales were weak in January
and March but, when adjusted for slightly lower inflation, household spending is strong enough not
to be an immediate Fed concern.
Figure 1: Not much for the market to work from
27th April Fed policy meeting statement, first paragraph
Information received since the Federal Open Market Committee met in March indicates that labor market
conditions have improved further even as growth in economic activity appears to have slowed. Growth in
household spending has moderated, although households’ real income has risen at a solid rate and
consumer sentiment remains high. Since the beginning of the year, the housing sector has improved further
but business fixed investment and net exports have been soft. A range of recent indicators, including strong
job gains, points to additional strengthening of the labor market. Inflation has continued to run below the
Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and falling
prices of non-energy imports. Market-based measures of inflation compensation remain low; survey-based
measures of longer-term inflation expectations are little changed, on balance, in recent months
16th March Fed policy meeting statement, first paragraph
Information received since the Federal Open Market Committee met in January suggests that economic
activity has been expanding at a moderate pace despite the global economic and financial developments of
recent months. Household spending has been increasing at a moderate rate, and the housing sector has
improved further; however, business fixed investment and net exports have been soft. A range of recent
indicators, including strong job gains, points to additional strengthening of the labor market. Inflation picked
up in recent months; however, it continued to run below the Committee’s 2 percent longer-run objective,
partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of
inflation compensation remain low; survey-based measures of longer-term inflation expectations are little
changed, on balance, in recent months
Source: US Federal Reserve
Note: Yellow shading indicates identical text, green shading indicates different text
What the Fed didn’t say says a lot
It is what the Fed left out of yesterday’s statement which was arguably more informative. The Fed removed
its previous reference to the (implicitly negative) “despite the global economic and financial developments
of recent months”. This suggests that it has taken on board the recovery in global equities and commodities

3. 3
as well as the recovery in Chinese economic activity. But, importantly, the Fed did not actually include a
statement about positive global developments. In a similar vein, the Fed removed the reference to US
inflation picking up in recent months, a likely nod to the fact that most measures of inflation had softened in
March. But the Fed stopped short of spelling this out.
This ties with my view that the Fed is still reluctant to attach too much weight to recent and potentially
transitory developments, whether positive or negative. Put differently, the Fed is telling us it needs more
data – and by extension time – to come to a firm conclusion on whether it can and should hike rates for
only the second time in a decade. With the next policy meeting due on 15th
June, the question is whether
data in the next seven weeks will provide the Fed with a clearer picture.
June hike still alive…just
The market doesn’t seem to think so. Pricing for a 25bp hike in June has narrowed, based on CME Group
Fed Fund futures prices. The Fed will likely want to keep its options open in June and thus be reluctant to
see the market totally pricing out a Fed hike, short of the US and global economy slowing more forcefully.
US treasury yields are thus more likely to stay within, than break out of, their two-month old ranges if the
Fed has its way.
But the Fed will have to contend with markets still attuned to the need and room for other major central
banks, including in Australia and New Zealand, to potentially cut policy rates further. The market’s violent
reaction to the Bank of Japan’s unchanged monetary policy at today’s meeting was a particularly stark
reminder that an overly-hawkish Fed could easily derail global risk appetite and in turn delay any Fed hikes.
The USD/JPY cross and Nikkei are both down more than 3% after the BoJ announced that it would not
ease monetary policy further for now. While the Fed is arguably not in the same precarious position as the
BoJ, it will have to accurately gage how sensitive markets are to even modest changes in its policy stance.
My core scenario of a June hike will therefore clearly be tested in coming weeks. The risk remains that
emerging market currencies, which have flat-lined in recent weeks, will come under pressure (see
Emerging Market currencies – don’t call this a comeback, 6 April 2016). If the Fed decides that it still needs
more compelling evidence for the merits of tighter US monetary policy, the next obvious trigger point is the
21st
September policy meeting when the Fed will publish new forecasts and hold a press conference.
The Fed will undoubtedly have an eye on the UK referendum on EU membership (23rd
June) and US
presidential elections (8th
November). It has historically remained apolitical and shown a willingness to look
through discrete global events and there is little to suggest this time will be different (see Fed – this is what
it sounds like when doves cry, 8 March 2016). But then again monetary policy is a very different beast than
it was even ten years ago.