FOMC: More Doom and Gloom

Overview:

Last night the minutes from the 10 March conference call and the 18 March monetary policy meeting were released. Generally, the minutes show a further intensification of the FOMC's concerns over the economic outlook, as the balance of risk between low growth and high inflation deteriorated significantly further in the inter-meeting period.

It is worth noting the minutes revealed that disagreement among the members about the extent of further appropriate monetary easing is building, as suggested by their being two dissenting members at the March meeting. However, for now, the committee clearly indicates that downside risks to growth remain its predominant concern, signalling that further rate cuts are on the agenda.

Details:

The minutes leave little doubt that the activity outlook for this year has been scaled down significantly compared to the January meeting. The staff substantially revised down the 2008 projection for economic activity, and the forecast now includes a contraction in real GDP during the first half of the year - a profile endorsed by many of the members. In the second half of the year, the economy is expected to revive slowly, with the economic stimuli from fiscal and monetary easing kicking in, but to soften again around the New Year, as the fiscal boost peters out. During 2009, economic growth is projected to return to abovetrend pace. Still some participants see downside risks to this outlook, believing "that a prolonged and severe economic downturn could not be ruled out given the further restriction of credit availability and ongoing weakness in the housing market ". Again a negative feedback loop between declining house prices, tighter credit markets and a deteriorating economy was emphasised as a risk to the outlook.

While the majority of the members continue to be mostly focused on the downside risks to growth, a minority of hawks (including Fisher and Plosser, who both dissented, preferring less easing) is becoming increasingly concerned about inflation. Moreover some members are arguing that the accommodation already provided should be allowed time to work and that it might be wiser to focus on more specific measures targeted at improving the efficiently of the transmission mechanism and market liquidity. The major concern is that continued aggressive easing, in combination with the recent, elevated inflation readings could deanchor inflation expectations. However, most members continue to expect that inflation will moderate as more slack emerges in the economy over the coming quarters.

Assessment & Outlook:

While the emerging disagreement among the members could prove a challenge for further easing in the upcoming meetings, there seems little doubt that the majority of members remain focused on the downside risks to growth and the fragility of the financial markets. Based on our expectation of a continued deterioration of economic data during H1 before fiscal and monetary stimuli act to stabilise the economy at some point in H2, we expect further easing ahead. We forecast a 50bp cut to 1.75% at the April meeting, followed by a terminal cut of 25bp to 1.50% at the June meeting.

Source : Actionforex.com

Today's Comment ...

FX & Money Markets Daily: Waiting For The ECB…

Majors & Scandies

Yesterday minutes of the March 18th monetary policy meeting in the Fed were released. It showed that all members of the FOMC but two voted in favour of cutting rates by 75 bps to 2.25% was passed unanimously. Fisher and Plosser who voted against the proposal preferred 'less agrressive action'. The minutes showed that members of the FOMC find economic developments concerning and that they believe that downside risks to economic growth have increased. Thus the FOMC acknowledged that 'some contraction in economic activity is likely' but at the same time they stated that 'monetary policy alone cannot address fully the underlying problems in the housing and finanscial markets'.

The concerned tone expressed in the minutes made market participants increase bets that the Fed will cut rates by another 50 bps later this month. Thus futures prices indicate that investors currently see a 42% probablility of a 50 bps cut versus a 58% probability of a 25 bps cut. In the FX markets the USD remains steady versus the EUR as investors await the monetary policy announcement from the ECB tomorrow.

Stock markets in Asia turned red this morning as Bank of Japan announced that rates were held unchanged at 0.50%. The poor market sentiment is likely to weigh somewhat on the JPY today and as momentum on EURJPY is tilting towards the downside we have chosen to recommend selling EURJPY at the current levels targeting 158.15 (Buy JPYDKK targeting 4.72).

Emerging Markets

Yesterday's inflation data from Czech Republic was lower than expected. Inflation was 7.1 % in March versus an expectation of 7.4 %. In February inflation was 7.5 % - the highest level in a decade. It looks like we finally have seen the top of inflation. However you should still keep in mind that the inflation target is 3 % and we still see a possibility for another rate hike of 25 basis points from 3.75 % to 4.00 % later this year. On the back of the lower than expected inflation data we recommend to buy EURCZK short term and we look for a level around 25.50 - if we reach that level existing loans should be closed. Long term we still cannot recommend new borrowing in CZK.

We look forward to the interest rate meeting in Iceland tomorrow. We expect a hike of around 100 basis points. The key rate is 15 % right now. For sure the Central bank will be very hawkish in its following comments. And in addition it is possible the Central Bank will take some steps to improve the situation for the local banks. We simply do not expect the Central Bank wants to disappoint the market and we see a very good possibility for a stronger ISK versus EUR in the coming days. Therefore we have changed our recommendation to SELL in EURISK.

Source : Actionforex.com