Four Central Banks Meet but FOMC is the Key

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The most important event this week is the FOMC meeting followed by a press conference by Yellen. In order to maximize its room to maneuver, we expect the FOMC statement will drop the patience that has characterized its forward guidance since last December.

This represents an evolution in the Fed's strategy to normalize monetary policy. They have reduced the time of their forward guidance from around six months (considerable period) to two meetings (patience). Yellen more or less executed the strategy that Bernanke outlined for tapering. Shifting away from the date-dependent approach to the data-dependent is under Yellen's leadership.

The Fed's biggest concern with the shift is that the markets will misinterpret this as a sign of an imminent hike. As she did in her Congressional testimony, we expect Yellen to explain that this is not the case. Indeed the next FOMC meeting April 28-29 and there is practically no chance of a hike then. However, the June meeting, which is followed by a press conference, is a different story.

We continue to see June as the most likely time frame for lift-off, but recognize the risk of a short delay, as the Fed did when it began the tapering in December 2013 instead of September as many expected. The data-dependency comes down to largely two considerations. First is the continued improvement in the labor market, broadly understood. Second, is that the FOMC has to be confident that inflation will rise toward 2% in the medium term.

Many participants recognize that the labor market is indeed healing.  It is the second condition that seems to be more troubling. Yet this is precisely what the FOMC statement said at the last meeting: "Inflation is anticipated to decline further in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate."

If the Fed does not drop the word patience, expectations of a June hike will ease considerably. This would likely spur a dollar correction and a rally in US stocks and bonds. If the Fed drops the word patience but softens this inflation expectation, this would also be a dovish development and weigh on the dollar and lift stocks and bonds.