FOMC Preview: Bernanke to Meet the Press

• We expect little change to the Fed statement tomorrow and no alteration to the purchase of treasury bonds through June.
• The Focus will be on the press conference with Fed chairman Ben Bernanke afterwards - the first of its kind.
• Overall, we expect a neutral message but if anything Bernanke may lean toward a more dovish tone following softer data recently and the possibility of more fiscal tightening than expected.
• Following the recent decline in yields, the market is now closely in line with our expectations of a first Fed hike in Q2 12. Despite a soft tone we believe further downside in yields is limited.

Little change to statement expected...

The news flow since the latest meeting on 15 March has been on the weak side, as Q1 GDP growth is shaping up to around 2% on the back of slower consumption growth. But we doubt it will change the Fed's overall assessment that the recovery is on a stronger footing as the labour market has continued to improve. The softer Q1 is mainly explained by higher oil prices and bad weather in the early months of the year. And the Fed will likely see these as temporary factors and look for growth to recover again in the second half of the year. This has also been the message from most Fed members lately.

On inflation data is also broadly in line with the Fed's description in the latest statement that underlying inflation is subdued. The three-month run rate of core PCE has risen recently but is still slightly below the Fed's comfort zone of 1.5-2%.

Inflation expectations have moderated to 2.9% from 3.2% in the Michigan consumer survey on five-year inflation expectations. This will give some relief to the Fed. However, bond market inflation expectations have turned higher and are at the high-end of the recent year's range. Overall the FOMC will likely reiterate that the rise in headline inflation is seen as temporary, but that it will pay close attention to inflation expectations. The Fed is also likely to signal a continuation of the purchase programme, which is due to end in June. This is also in line with consensus as the softer tone of data has tempered speculation that the Fed could end QE2 ahead of schedule.

...but risk of more dovish tone on press conference

The meeting today will be historical as the Fed will now introduce press conferences following the statement. These will only take place four times a year when the Fed releases new projections. These projections are normally published with the publication of the minutes but will now be available for the press conference.

The press conference is an opportunity to give more colour to the statement and new projections. We see the risk of a slightly dovish tone in response to the recent weaker data. Especially in the latest week, we have seen a steeper decline in house prices than expected and softer business surveys from Philly Fed and Richmond. Bernanke is representing the more dovish camp and this may be reflected in his tone.

Another key aspect in focus at the moment is the need for fiscal tightening. It is becoming increasingly apparent that the US government can no longer postpone fiscal tightening. With current plans fiscal policy will subtract a little more than 2 percentage points from growth in both 2012 and 2013. This may also add to hesitancy over the strength of the recovery in the medium term among some FOMC members.

Market now in line with first hike in 2012

The end of the asset purchase programme in June will mark an important point as monetary policy is effectively locked until then. After June we expect the Fed to gradually start to prepare the ground for monetary tightening. However, we do not expect a first 25 basis points of Fed funds rate hikes before Q2 next year, followed by another 25bp rate hike in each subsequent quarter.

After the recent decline in bond yields this is quite close to current market pricing. The market now prices the first hike at 100% in May 2011. Hence despite a cautious tone from Bernanke we see limited room to the downside in yields.

With the Fed on hold for some time and the ECB continuing to hike this continues to support a continued rise in the EUR/USD level.

Recent key statements from FOMC members

Fed members have generally been quite split recently with a four hawks (Lacker, Plosser, Hoenig and Fisher) turning up the volume, whereas the more dovish camp of chairman Bernanke, vice-chairman Yellen and New York president Dudley have tempered the hawkish tone - see also Flash Comment - US: What to make of recent Fed speak. The latter three belongs to the inner circle, though and are much more influential in terms of setting Fed policy.

Fisher (voter, hawk) on 18 April

Comments on oil price rise: "It is a double whammy" as "it slows down our economy" and "adds to inflationary pressures". On growth: "I still think we have a self-sustaining recovery, but I expect to have some moments of hesitancy and that may well have occurred in the first quarter" due in part to the rise in energy prices. On liquidity: "no further amount of monetary accommodation would be wise". On inflation: "unpleasant" price reports may occur in the next couple of months.

Bullard (non-voter, hawk) on 18 April

"Fed probably won't taper end off QE2 purchases. Inflation expectations aren't terrible now. Current oil price little drag on US economy. US growth prospects remain reasonably good for 2011".

Evans (voter, neutral) on 15 April

"I'll be surprised if I'm advocating a tightening in policy in 2011". Oil prices usually have a "pretty insignificant effect" on core inflation."This does not seem to be an environment where strong wage growth is likely to take place"

Plosser (voter, hawk) on 15 April

"We have to be careful not to let those higher prices get translated into more broadbased higher inflation". Interest rate hike "not inconceivable" this year.