Now that the Federal Reserve has announced that its policy stance after June will be entirely “data determined”, the markets are watching the flow of information on US economic activity even more carefully than usual. Since 2010, there has been a recurring pattern in US GDP projections. They start optimistically, but are then progressively downgraded as the economic data come in.
Entering 2015, I was fairly confident that this depressing pattern would finally be overcome, but not so far. In the last few weeks, there has been a sharp downward adjustment to GDP growth estimates for the first quarter, and this has added to the market’s scepticism about whether the Fed will be ready to announce lift off for interest rates this summer.
Chair Yellen’s important speech on Friday again expressed concern that the rise in the dollar might be negatively affecting net exports (explicitly mentioning the drag from the dollar no less than three times, which is unusual for a Fed Chair). She also warned that:
The economy in an “underlying” sense remains quite weak by historical standards.
Nevertheless, the FOMC remained fairly upbeat about immediate prospects for US GDP, reducing the “central tendency” for growth in the year ended 2015 Q4 by only 0.3 per cent to 2.3-2.7 per cent, a little above trend. Ms Yellen explained that this reflected optimism about consumer spending in the context of low energy prices and a strengthening labour market. She summarised her views as follows:
Overall, I anticipate that real gross domestic product is likely to expand somewhat faster than its potential in coming quarters, thereby promoting further gains in employment and declines in the unemployment rate.
Unfortunately, this optimistic view is already being challenged by weak economic data in the first quarter. It would not take much further weakness in the second quarter to wobble the confidence of both the Fed and the markets. Read more