Despite the pleasant surprise in the first quarter GDP growth, the Fed would still leave its policy rate unchanged at the upcoming meeting. The Fed funds rate target is expected to stay at 2.25-2.50%. Its forward guidance would stay unchanged, calling for patience in future monetary policy move. At the meeting, the key areas of interest include the members’ inflation outlook, the threshold for a rate cut, as well as more updates on the balance sheet policy.

GDP growth improved to +3.2% q/q (annualized) in 1Q19, from +2.2% in the prior quarter. The market has anticipated only a +2% growth. Despite the headline surprise, much of the expansion was driven by trade and inventory – two of the more volatile components. Excluding these two components, growth was about +2% in the first quarter. This is certainly not a weak figure. Yet, it is not enough to alter the Fed’s guidance. Household spending, taking up 70% of the country’s economy, contributed about +0.8 percentage point to growth.

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Inflation remains soft. Core PCE, Fed’s preferred guage, moderated to +1.3% y/y in 1Q19, from +1.9% in the previous quarter. This also came in weaker than consensus of +1.6%. The job market should remain resilient. Scheduled to release on Friday, nonfarm payrolls probably increased +180K in April, compared with +1.96K addition a month ago. The unemployment rate is expected to stay unchanged at 3.8%- a rate that this is far below FOMC’s long-term target of about 4.5%. Wage growth is expected to have gained slightly. The market forecast that average earnings have risen +3.3%y/y in April.

In March, the Fed announced material changes to the balance sheet reduction plan. From May to September, the Fed would cut the size of Treasury securities reduction by half, to US$15B/ month, while the size of mortgage-backed securities (MBS) reduction stays unchanged at US$ 20B/ month. From October onward, the Fed would stop reducing its Treasury position. Rather it would take up to US$20B/ month in maturing mortgage securities and roll them into Treasury debts. We expect the members to discuss more details including the long-run size and composition of the balance sheet.

While a rate cut is unlikely at the upcoming meeting, there have been discussions about the scenarios under which the Fed would consider reducing the policy rate. One of such is when inflation continues to falter while economic growth remains firm. We expect related questions at the press conference.

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