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FOMC Preview – Cautious about Economic Weakness but Fiscal Stimulus should lend Support

The FOMC meeting in the coming week will not bring any change in the monetary policy. Economic activities have moderated since the December meeting, while resurgence in the coronavirus cases could hurt economic activities more seriously than previously expected. Yet, roll-out of more fiscal stimulus and positive vaccination progress suggest that policymakers might keep the powder dry from some time. The Fed will leave the asset purchases at US$120B per month and the Fed funds rate at 0-0.25%. All forward guidance will stay unchanged.

Economic data released since the December meeting indicated a loss of momentum in the recovery process. The unemployment rate steadied at 6.7% in December. However, the number of payrolls dropped for the first time in 6 months. Retail sales gained +3.7% y/y in November, easing from +5.4% growth in the prior month. Flash reading of the Markit composite PMI dropped -2.9 points to 55.7 in Decmeber, Both manufacturing and serviced activities slowed during the month. Scheduled for release in the coming week, GDP probably expanded +4.2% q/q (annualized) in 4Q20, after a strong +33.4% growth in the prior quarter.

Inflation remains below the +2% target. Although headline CPI in December picked up after 2 consecutive monthly drop, it only reached +1.3%. Meanwhile core CPI has been grinding lower after reaching a post-pandemic “high” of +1.73%. On a positive note, expectations on future inflation have improved. The implied breakeven inflation rates on index linked bonds is rising for all maturities with the 5-year rising from to 1.9% in mid-December to 2.18%, while the 10-year rising to 2.1% from 1.92%.

The pandemic situation has deteriorated since the last week. The resurgence in the coronavirus cases suggests economic activities will be affected in the first quarter of this. The positive news is that vaccination progress remains on track. A of January 22, about 5% of the population have received at least one dose of the coronavirus vaccine. Besides, Political uncertainty has been reduced after Joe Biden’s inauguration and with Democrats controlling both houses. Hopes for smooth passage of Biden’s US$1.9 trillion stimulus plan have increased.

Against this backdrop, the Fed at the coming meeting should acknowledge weakness in the economic data flow. Yet, it would also take note of better inflation expectations and hopes on further stimulus. All in all, the monetary policy measures would stay unchanged. We do not expect much discussion about tapering of asset purchases. The Fed had only introduced a forward guidance last month that it would increase its Treasury holdings by at least US$80B per month and its MBS holdings by at least US$40B per month “until substantial further progress has been made toward the Committee’s maximum employment and price stability goals”. We expect this stance would be maintain.

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