Analyzing Policy Divergence Ahead of Fed Meeting

  • Monday, July 24, 2017

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This week’s Fed meeting is likely to be the biggest market-mover in an otherwise quiet week. Fed sentiment has fallen in recent months, making it unlikely that policymakers will alter rates or even hint at a coming rate hike, though a December rate hike remains a distinct possibility. The prospect of balance sheet unwinding remains far more realistic, and the FOMC could take this opportunity to outline their plans in more detail. Any such detail would indicate that the Fed is looking to begin balance sheet normalization in September. However, with trend on the dovish side of neutral, numerous hawkish speeches with technical details about balance sheet unwinding would be needed for Fed policymakers to clearly signal their intent.

Unlike the Fed’s descending sentiment trend, sentiment from both the ECB and BOJ has recently been on the upswing. Neither bank is likely to remove monetary accommodation anytime soon due to persistently low inflation in both economies, but strengthening growth has resulted in more hawkish rhetoric, even as policymakers seek to avoid tighter financial conditions. Similarly, RBA policymakers have already begun backing off on their recent hawkish remarks that were immediately (mis)interpreted to indicate a forthcoming rate hike. This week’s lone RBA speaker will likely take great care to avoid presenting any hawkish signals.

Overall, the story from major central banks in recent months—especially the last few weeks—has been that of policy divergence. A year ago, divergence meant the Fed was becoming more hawkish as the ECB, BOE, and BOJ all continued to engage in stimulus, but now the story has reversed. The Fed appears to be sliding more dovish—though policymakers clearly still have a preference for tighter policy—while the ECB, BOE, BOJ, BOC, and RBA are all inching toward tighter policy. The BOC has been the first to actually execute on tighter policy. Should this trend continue, the Fed may be in a holding pattern for a while as other major central banks begin to catch up.

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The Prattle Team

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