Central Banks fail to disappoint

Central bank decisions, forward guidance or even a word change in policy statements move markets.

Not that anyone has to be reminded about this truism of course. The world's four major central banks - the Fed, the ECB, the BOJ and the BOE - and the RBA met over the past forthnight and not a single one failed market expectations.

Perhaps, the central banks' assessments and outlook are currently in sync with that of the financial markets. This is underscored by Factset's recent report that even the International Monetary Fund (IMF) "endorses the ECB's cautious approach". Or is it because the financial markets are wagging the central banks? Can't disappoint markets or they'll throw a tantrum that could derail continued progress in macro- dynamics and therefore, the outlook.

The RBA, the ECB, the BOJ and the BOE all kept monetary policy unchanged at their latest meetings, as expected. The US Federal Reserve lifted the fed funds rate from 0.75% -1.0% to 1.0% - 1.25%, as expected; maintained its outlook for three interest rate hikes total for this year (one to go), as expected; and, confirmed that it would start trimming its US$4.5 trillion balance sheet this year, as expected.

According to the Fed statement,

"In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation."

As for the Fed's balance sheet, "The Committee currently expects to begin implementing a balance sheet normalization program this year..."

The accompanying addendum to the Committee's Policy Normalization Principles and Plans, lays out the details:

"For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month."

"For payments of principal that the Federal Reserve receives from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month."

"The Committee also anticipates that the caps will remain in place once they reach their respective maximums so that the Federal Reserve's securities holdings will continue to decline in a gradual and predictable manner until the Committee judges that the Federal Reserve is holding no more securities than necessary to implement monetary policy efficiently and effectively."

One carefully laid out plan if I ever saw one. Not only that, there's also a Plan B, just in case.

"However, the Committee would be prepared to resume reinvestment of principal payments received on securities held by the Federal Reserve if a material deterioration in the economic outlook were to warrant a sizable reduction in the Committee's target for the federal funds rate. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate."

Just as well. This is because while the Fed sees the first quarter slowdown - GDP slowed to an annualised 1.2% rate in the March quarter from 2.1% in the December quarter - as "transitory", and one that should provide an easy comparison when the second quarter figures are estimated, partial indicators for the second quarter are not so plush.

US retail sales growth have trended lower from 4.8% year-on-year growth in March to 4.6% in April and 3.8% in May. There's a similar downtrend in inflation as well. Headline inflation's has eased from 2.7% in February to 2.4% in March to 2.2% in April and 1.9% in May while the core inflation rate has progressively come down from a five-month high of 2.3% in January this year to 1.7% in May.

On top of these, the "upside risks" to the Fed's forecasts, i.e. the promised Trumpflation - tax cuts and fiscal spending - remain promises.

Should the current weakening in consumer spending and inflation persist, financial markets would adjust expectations to suit ... and so will the Fed.

Read more: FedECBBOEBOJUS Federal ReserveFactsetInternational Monetary Fund
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