FOMC Preview: Use the force, Janet!
The US Federal Reserve (Fed) began its first two day policy meeting for 2016 yesterday. will be watching for any signs of cautiousness expressed by the Fed as a result of recent market volatility. We believe that the Federal Reserve will try to calm markets and highlight the positives driving the US economy (e.g. Low unemployment).
At the last meeting the Fed raised their benchmark interest rate by 0.25%, for the first time in since 2006. Although more hikes are likely (2-3) over the course of 2016, we think that won’t be until the latter part of the year. No movement on interest rates at this meeting is expected. The Fed will want to provide stability to markets and reiterate that their policy changes will be gradual and responsive to the economic environment around them.
They have the ability to influence the direction of markets and we believe that Janet Yellen (the Fed Chairman) should exercises this power to reassure financial markets in what has been a turbulent start to the year.
RBNZ Likely to Leave Cash Rate at 2.50%
Closer to home, tomorrow is the first Reserve Bank of New Zealand meeting of 2016 since the RBNZ cut its official cash rate (OCR) by 0.25% to 2.50%.
There has been little in the way of major changes since the previous meeting and accordingly we believe the RBNZ will remain on hold at 2.50%. The hurdle rate of a further reduction in the OCR is high and consequently we believe that the OCR will remain at 2.50% for the medium term.
Despite dairy prices remaining weak and the effect of El Nino continuing to effect farmers, there are a number of bright spots in the economy. The retail sector appears to be benefiting from low interest rates and tourism is a major benefactor of a lower NZD. Net migration has reached a historic high which is providing further growth in the economy. These positives are starting to feed into the performance of the wider economy with the September GDP beating expectations coming in at 0.9% for the quarter.
The major risks to the economy remains to be the struggling farming sector. Dairy auction prices suggest a possible downward revision of Fonterra’s 2016 projected NZ$4.60 kg/MS payout to around the NZ$4.25kg/MS level. We do believe that dairy prices will recover once the oversupply factors are addressed. At current prices we have already seen a material decline in the amount farmers are selling on the open market. Further, the NZ dollar has continued its downward trajectory and this will be further benefiting farmers and the wider economy.
Below we have set out the factors for/against a RBNZ rate cut tomorrow:
Chart of the Moment