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Housing Numbers Will Not Discourage the Fed

Last updated 3/16/2010 8:59 AM ET (GMT -5) 3 Comments

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Kathy Lien

Director of Currency Research, GFT

Forex traders were completely unfazed by the mild disappointments in this morning's U.S. economic data. Since today is FOMC day, the only thing the market is worried about is the outcome of the Fed meeting and whether the Fed will underwhelm. 

In terms of the data, housing starts fell more than expected in February while building permits dropped less than expected. These housing market numbers are notoriously volatile on a month to month basis and the data this month was artificially affected by the storms in the Northeast. If there is one sector that would be directly impacted by weather problems, it would be construction. However the large upward revision in January is another reason why traders were not discouraged by last month's disappointment. Like non-farm payrolls, what was taken back in February will most likely be added back in March. Meanwhile with import prices falling 0.3 percent last month, inflationary pressures are modest. The lack of inflation could be a contributing factor to the Fed's decision to include or exclude their pledge to keep interest rates at extremely low levels for "extended period."

The central focus of the upcoming FOMC meeting will be on two words – “extended period.” If the Fed decides to drop the phrase, the dollar will probably rally as the Fed’s hawkishness satisfies dollar bulls but if they leave the phrase intact, traders will most likely express their disappointment by selling dollars. Another key factor to watch is the number of members who dissent and say the phrase is no longer needed. As usual, interest rates should remain unchanged at 0.25 percent.

What will be the Tone of the FOMC Statement?

The primary reason why we believe that the Fed could grow more optimistic is the prospect of strong job growth in March. Non-farm payrolls fell much less than the market had anticipated in February and with jobs affected by the snowstorms set to be added back this month, there is a strong possibility of positive job growth in March. The improvement in the labor market should also encourage consumer demand, particularly given the rise in retail sales for everything except for autos. There have been many areas of improvement since the January monetary policy meeting and if the Fed doesn’t want to fall behind the curve, they could choose to acknowledge the improvements tomorrow. At the same time however, they could remain cautiously optimistic because consumer confidence has deteriorated. Yet the Fed could also choose to wait for further improvements in retail sales before committing to a tightening cycle. Inflationary pressures are relatively modest and it is unclear whether the pace of expansion in the manufacturing sector has slowed. As a result, the Fed may want to wait for more signs of solid economic growth before tinkering with their outlook on interest rates. With such a difficult conundrum, we believe the Fed will err on the side of caution by growing slightly more optimistic in their economic outlook, but keep the phrase “extended period” in the statement, which could be initially negative for the dollar. In the long run however, compared to European central banks, the Fed is still closer to raising interest rates and therefore the sell-off in the dollar should be limited.

Number of Dissenters

Don’t forget to also keep an eye on the number of dissenters. Back in January, Kansas City Fed President Hoenig voted against the policy action. He believed “that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted.” If additional policymakers dissent, it would be a sign of increasing hawkishness within the Fed. Most Fed officials have said that interest rates will remain at low levels for an extended period of time but late last month, Fed President Evan provided some clues on what this phrase really means. In a TV interview, he said, “extended period of time (to him) means 3 to 4 FOMC meetings.” Considering that Evans is generally perceived as one of the more dovish members of the FOMC, his timing for rate hikes should not be ignored. This means the Fed could be looking to raise rates at their June, August or September meeting which is in line with our internal timeframe for an end of the third quarter, beginning of the fourth quarter rate hike.

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Comments (3)

Semaj

March 16, 2010 at 09:41 AM ET

K, isn't there a catch 22 in construction. Right now rates are low but borrowing is not easy, in fact very difficult. Next will come the money being lent out as confidence increases due to the recovery but then rates will go up and interested borrowers will decrease. Wont this drag out the depressed housing market?

Semaj

March 16, 2010 at 12:47 PM ET

Your calendar says 1:15 est for FOMC but it is usually 2:15. Is that a typo?

klien

March 16, 2010 at 12:50 PM ET

It is 14:15 EST so should be 18:15 GMT. Our clocks are on GMT. Have to tell the developers to change the EST conversion. Thanks

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.