Fed Downgrades Assessment of US Economy

Negative effects of low oil prices and strong dollar expected to wear off
April 29, 2015 Updated: April 29, 2015

The Fed is singing a similar tune to the Bank of Canada in that first-quarter economic growth slowed, but the U.S. central bank appears more tempered in its expectations for improvement in the economy later in the year.

The Federal Open Market Committee (FOMC) kept the federal funds target range unchanged at 0 to 0.25 percent on Wednesday, April 29, just as it strongly hinted it would at its last meeting in March. From here on in though, rate hikes are fair game, provided the economy shows a lot more strength.

According to the FOMC, “The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labour market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”

Labour market underutilization “was little changed”—meaning not improving the way the Fed would like it to. This characterization was a downgrade from March when the Fed described labour market underutilization as “continued to diminish.” Earlier in the month, the March jobs number was a disappointing 126k.

Inflation seems to have stabilized in the U.S., albeit at below-target levels, and the Fed sees it moving back to target as the temporary effects of low oil prices and import prices wear off.

With appropriate policy accommodation, economic activity will expand at a moderate pace.
— Federal Open Market Committee

The low import prices is a reflection of the strong U.S. dollar, which has weakened in recent weeks, consistent with the wobble in the U.S. economy and rate hikes being pushed further into the future. The Canadian dollar is trading at its highest levels in nearly three and a half months against the greenback.

Rough First Quarter

Earlier on April 29, a preliminary reading on first-quarter GDP came in weaker than expected (0.2 percent vs. expectations of 1 percent). The Fed statement attributed some of this weakness to the harsh winter. U.S. GDP grew by 2.2 percent in the fourth quarter of 2014.

The Canadian economy was similarly affected and the Bank of Canada is expecting no first-quarter economic growth.

Other key areas cited by the Fed as being still weak or declining were the housing sector recovery, exports, household spending, and business fixed investment.

The Bank of Canada went to some lengths to point out on April 15 how the strength in Canada’s non-energy exports (machinery, metal products, airplane parts among others) is gaining traction.

But the Fed doesn’t sound as convinced, saying, “Business fixed investment softened, the recovery in the housing sector remained slow.” Improvement in the U.S. housing sector is a key factor in Canada’s non-energy exports continuing to grow.

The Bank of Canada expects strong second-quarter growth in the U.S. after a weak first quarter. In its April Monetary Policy Report, the BoC projects the U.S. economy to grow 2.7 percent in 2015.

There was very little immediate market reaction to the release of the Fed statement. The U.S. dollar strengthened slightly but stocks and bonds were essentially unchanged. The Canadian dollar weakened from about US$0.8350 to US$0.8325 shortly after the 2 p.m. press release.

Given the assessment of the U.S. economy, markets are not expecting a rate hike in June. The FOMC “continues to expect that, with appropriate policy accommodation, economic activity will expand at a moderate pace,” the Committee said in its press release.

The next Fed meeting concluding June 17 will provide updated economic projections, and Fed chair Janet Yellen will be speaking at a press conference.

Follow Rahul on Twitter @RV_ETBiz

Follow Rahul on Twitter: @RV_ETBiz