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Balanced assessment
Today, the FOMC had to acknowledge that economic growth slowed during the winter months. The pace of job gains moderated, the unemployment rate remained steady, and a range of labor market indicators suggests that underutilization of labor resources was little changed. Growth in household spending declined, business fixed investment softened and exports declined. The FOMC also repeated that the recovery in the housing sector remained slow.
However, the FOMC also added that the slowdown was in part reflecting transitory factors and that households’ real incomes rose strongly, partly reflecting earlier declines in energy prices, and consumer sentiment remains high.
In other words, the FOMC does expect a reacceleration after the disappointing first quarter, because the impact of transitory factors such as the weather and port strikes will fade. What’s more, household incomes and consumer sentiment may boost personal consumption growth. However, the FOMC also acknowledges that the slowdown is only in part caused by temporary factors. A factor that will continue to play a role after the winter is the appreciation of the US dollar that we have seen in the last 12 months and that has become a headwind for US exporters: a year ago, the EUR/USD stood at 1.38, while today it is 1.11.
The Fed’s words on inflation were largely repetitive with inflation continuing to run below target, partly reflecting earlier declines in energy prices, while market-based measures of inflation compensation remain low, but survey-based measures of longer-term inflation expectations have remained stable. However, the FOMC did add that inflation is running below target also because of decreasing prices of non-energy imports. Note that this is also a result of the dollar appreciation.
All’n all, the FOMC statement gave a balanced assessment of the current economic slowdown and the Committee remains very much in a data-dependent mode. However, the balanced and cautious tone in the statement is a far cry from the optimism and (over)confidence that we have seen in previous statements. This suggests that the large majority of doves in the Committee is in no hurry to hike and instead is waiting for solid evidence that the economic recovery can actually deal with a rate hike.
Don’t shoot yourself in the foot
What does this mean going forward? The Fed’s downgraded economic assessment came after the release of Q1 GDP growth earlier today, which turned out even lower than expected: 0.2% quarter-on-quarter at an annualized rate is close to an economic standstill. The slowdown in personal consumption to 1.9% and residential investment to 1.3% was accompanied by an outright 3.4% contraction in business investment and a negative contribution of net exports to GDP growth of 1.25%. This suggests that we cannot attribute the entire GDP growth slowdown to the weather. The appreciation of the US dollar in recent months is undermining the international competitiveness of US exporters and reducing their incentives to invest. In addition, the decline in oil prices has reduced the incentives for investment in the energy sector more specifically. These factors will continue to play a role after the winter, so it may take some time before we see the US economy in full swing again.
The impact of the dollar appreciation is not only holding back economic growth, but also core inflation. Ironically, the strength of the dollar is for a large part caused by expectations of the Fed’s monetary tightening. What’s more, an actual rate hike could lead to further appreciation, giving US exporters hardly any time to adjust to their loss in competitiveness and keeping down core inflation. A premature rate hike would slow down the return of inflation and unemployment to their targets. Therefore, we continue to expect the Fed to delay the first hike to the final quarter of the year.