A look ahead to the FOMC

The next three weeks include some key events in the majors. The US FOMC meeting concludes on Wednesday (28th January). The ECB and the Bank of England both announce interest rates eight days later (5th February). G7 leaders then head off for their summit in Florida (6-7th) followed by Greenspan's first half-yearly testimony on US monetary policy (11-12th).

The common theme will be the desire to avoid rocking the boat. The world economic environment looks healthier than it has been for many years. The US and Asian economies are already strong, European business confidence is recovering, and global bond and equity markets are behaving well. Currencies may be behaving badly in the eyes of some, but there is little evidence that is causing problems in other asset markets or the real economy. Indeed a sense of normality has already returned to the FX markets after heavy selling of the dollar over the holiday period. Sentiment towards the USD is still negative, but improving economic and flow data suggests that it is no longer such a one-way bet. Policymakers will not want to disturb this by radical policy shifts or extraordinary statements. Stability and predictability will be the aims.

We will focus here on the Fed, then discuss the other meetings nearer the time. For now, we see no change from the ECB, a 25bp hike from the BoE, and the usual words but no action from the G7 meeting. European and Japanese officials are again flagging FX moves as a potential topic, though this would hardly be a surprise. More importantly, neither the US nor China looks set to change their positions.

Ahead of the Fed, the markets are speculating whether the FOMC will retain the phrase that 'policy accommodation can be maintained for a considerable period.' Some people interpret that as a 'commitment to keep rates on hold'. Our view is that this phrase is so vague as to be meaningless: maintaining 'policy accommodation' does not mean that rates cannot rise as long as they remain low enough to boost growth, and 'considerable' could mean anything. So the Fed might as well keep the markets happy by retaining the phrase for another couple of months until the data make it clear that rates need to rise soon.

The other issue is the bias. The current language is that 'the upside and downside risks to the attainment of sustainable growth are roughly equal', while 'the probability of an unwelcome fall in inflation has diminished in recent months and now appears almost equal to that of a rise in inflation'. In both cases there is now a strong case for an upgrade. The ISM surveys are clearly signaling growth well above the 3-3.5% that might be sustainable. Core inflation is currently low, but leading indicators of future inflation (which is what the bias is about) are starting to rise. That would justify a shift from an overall 'easing' bias to 'neutral'.

However, at this stage keeping the 'considerable period' could be more important. The Fed has already moved within a whisker of reverting to neutral by saying last month that the risks to inflation are now 'almost equal'. The final step from easing to neutral may also have limited impact because few people seriously expect the Fed to cut again. Instead the big issue is how long before rates go up, and hence the language on the 'considerable period' has more significance. It is therefore a close call whether the Fed will change the bias this time, and debatable too whether it really matters. We think it would make sense to revert to a neutral bias now, but the FOMC might be reluctant to send mixed signals by changing the bias while retaining the language on the 'considerable period'.

The only significant change in the rest of the statement is likely to be an acknowledgement that recent payroll numbers have been disappointing. Assuming the 'considerable period' is kept, the overall message is therefore likely to be 'dovish'. Nonetheless, whatever the Fed says this week, the statement should soon be overtaken by new data from the ISM (2nd and 4th February) and the January labour report (out on the 6th). We expect those numbers to be strong. Friday's Daily took a closer look at the payrolls, where the early consensus for this month is 200k and our forecast is 300k. Greenspan's testimony in February - the so-called Humphrey-Hawkins testimony to the House and the Senate - will also have to reflect these numbers. His comments will therefore be far more important than the FOMC statement in setting the scene for the remainder of the year.