In the Run-Up to the FOMC

The US dollar is narrowly mixed ahead of the FOMC meeting, where a dovish
hike seems widely expected.
  The Australian dollar is leading the
dollar bloc and Scandis higher.  The Aussie had to shrug off soft consumer
confidence a day before the monthly employment report
and perhaps was encouraged by the recovery in iron ore prices after initial

China’s data may have also been supportive.  Chinese consumers
continue to shop.  Retail sales rose 10.7% year-over-year in May, and the year-to-date pace of 10.3% is the
highest this year.  Industrial output rose 6.5%, the same as in April, and
a little more than expected.  Fixed asset investment slowed to 8.6% from
8.9%.  While a slowing in investment in China is seen a healthy development, reducing a significant
imbalance, the details are a bit worrisome.  Investment growth in the
primary sector increased more than investment in manufacturing and

Separately, China’s lending increased, but the deleveraging,  which
officials saw is behind the slowing of M2 (to 9.6% from 10.5%), is seen in the
shadow banking. 
New yuan loans increased by CNY1.11 trillion, a
little more than April and an 11% more
than expected.  However, aggregate financing rose a little less (CNY1.06
trillion); the difference being a small
contraction in non-banking lending

It was not enough for Chinese shares.  The Shanghai Composite
cut this year’s gains nearly in half was a 0.75% decline, and the 1.3% loss by
the CSI 300 is the largest this year.  Despite these losses and a small decline in Tokyo and Taiwan,
the MSCI Asia Pacific Index rose for a second session (~0.12%).  
European shares are also higher; led by a recovery in the information
technology space.  Perhaps aided by the 0.5% rise in the eurozone’s April
industrial output, and an upward revision to the March series (0.2% rather than
-0.1%), is helping the industrial equities.  

Sterling had extended yesterday’s recovery and traded to almost $1.28
before poor weekly earnings data stopped it in its tracks.
weekly earnings, excluding bonus payment,
rose 1.7% in the three months through April from a year ago.  The slowing actually took place in March, which was revised from 2.1% to 1.8%.  The fifth
consecutive slowing brings the pace to its lowest level in more than two
years.  Whatever difficulty one may have thought the slightly firmer than
expected CPI would have on the BOE deliberations, the weakness in the earnings
data offsets it, and more.  The higher inflation coupled with weaker
nominal earnings suggest a squeeze on real income, which in turn may weigh on
consumption. A break of $1.27 warns of a retest
of sterling’s recent lows. 

For their parts, the euro and yen have barely changed.  The euro
has been confined to less than a quarter of a cent as it continues to
consolidate.  Support is seen in the
$1.1165-$1.1185.  The euro has not been above $1.1240 since June 8. 
Meanwhile, the dollar continues to straddle the JPY110 area.  Today is the
fifth consecutive session it has traded on both sides of JPY110.  Note
that the Bank of Japan (the Bank of England and the Swiss National Bank) meet

Ahead of the FOMC meeting, the US reports May CPI and retail sales. 
The year-over-year headline pace of CPI may slow, however, the core rate is
expected to be steady at 1.9%.  It has declined for three consecutive
months, like the core PCE deflator, and this has begun being concerning to
investors and policymakers.  The market may be particularly sensitive to
downside surprises, and will also focus on the Fed’s comments and inflation

Some of the factors that may slow headline CPI may also act as a drag on
retail sales, as the drop in gasoline
We already know that auto sales disappointed.  Headline
retail sales are expected to be flat, but the components used for GDP may rise
0.3% after a 0.2% rise in April.  

The market has practically fully discounted a 25 bp hike in the Fed funds
target range today.  Investors are more interested in the forward guidance
rather the rate move itself. 
In some ways,
Governor Brainard framed the issue recently.  Economic growth and prices
may be disappointing, and this may make officials cautious about continuing to
normalize policy.  On the other hand,
financial conditions are looser than the Fed deems appropriate.  They have wanted to remove accommodation, but a wide
range of rates are lower, the stock market is higher, and the dollar is weaker.

However,  before reaching the conclusion that monetary policy is not
effective, investors and policymakers will likely keep in mind that such policy
acts with unpredictable and variable lags.
  It was slow to take effect
in the depths of the crisis, and it is
slow to take effect on the other side.    Yellen will likely
stress the data dependency of the FOMC.  It seems that the potential need
for a tactical adjustment is possible precisely because Fed policy is not
dictated by some rule-based system.   Bloomberg and the CME
calculations show a little less than a 40% chance of another hike this year

Investors are also looking for more details about the Fed’s balance sheet
Such information is more likely to be found during Yellen’s
press conference rather than the FOMC statement.    The general
thrust of the Fed’s strategy is beginning
slowly to cap the reinvestment of maturing funds and gradually ratchet it
up.  The Fed funds rate will remain the primary tool of monetary
policy.  The inclination is to include both Treasuries and MBS in the
program.  The program may begin before the Fed decides the terminal size
of the balance sheet.  


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