The policy statement released on Wednesday by the Federal Reserve’s Federal Open Market Committee (FOMC) represents a continuation of the “wait-and-see” trend anticipated by the market. The Fed continues to keep the door open to interest rate policy normalization, which it began in December, with the pace of change dictated by economic data and financial conditions. Overall, economic data in the U.S. have marginally deteriorated since the central bank embarked on rate normalization away from emergency conditions, but the Fed’s mandated objectives of full employment and price stability are still largely on track for continued tightening this year, even if at a slower pace than anticipated. Indeed, the language of today’s statement highlighted some of those concerns, for example mentioning that “business fixed investment and net exports have been soft.” Also, vitally, the FOMC stated that “…global economic and financial developments continued to pose risks,” underscoring the extent to which external economic and financial market stresses can influence Fed policy today.

Further, the FOMC’s changes to its Statement of Economic Projections (SEP) also highlight the likely slower path of interest rate change this year, and some continued uncertainty over U.S. growth prospects in a world of slowing economic growth overall. For example, the Fed downgraded real GDP growth projections in 2016, from the 2.4% it had assumed in December to 2.2% today, with 2017 growth also witnessing a modest reduction.  We agree that the data will continue to marginally deteriorate from here, which justifies the Fed’s lowered anticipated “dot-plot” path of one or two more hikes by year-end, versus the four implied by the December SEP. We believe the door was open to beginning this normalization process a couple years ago, and to some extent the Fed missed its optimal window of opportunity to normalize rates in an easier manner. Today, the central bank must contend with payrolls growth that is likely peaking, challenging financial market conditions from abroad, and an inflation rate that appears to be firming.

Unlike some others, we don’t believe the U.S. economy will enter a recession anytime soon, but labor market growth will slow in the quarters ahead, as companies are scaling back expenditures of all kinds (capital expenditures, hiring, and inventory-builds, for example), as their top-line revenues and earnings decelerate. Moreover, changes to headline payrolls tend to lag corporate earnings/profits changes by a six-month time frame, so the rolling over of the growth rate of corporate profits in recent quarters should feed through to a worsening jobs picture by the back half of 2016. Further, temporary hiring has started to slow, which historically has been a signal of future weakness in payrolls growth, as it hints at changes in the supply/demand of labor. All these dynamics put the Fed in a difficult position regarding normalizing rates, since the economic cycle may be moderating as the central bank seeks to raise rates.

We are not arguing that these dynamics represent a tangible economic weakness that threatens the recovery, but rather that slowing payrolls growth is likely to keep the Fed’s rate normalization path more contained than outlined at the December meeting, and perhaps even than the path implied by today’s SEP. We also think there is a tangible wage and inflation lag, and believe that this will also play out going forward, as we have recently witnessed with current inflation data, such as Average Hourly Earnings, the CPI and Core PCE readings.

Generally speaking, it is not the U.S. consumer that concerns us, as consumer spending is likely to support the economy on the back of very strong employment growth over the past few years and potentially improved wage growth in the year ahead. What does concern us, though, is another potential economic fault line, the fact that a variety of corporate sector metrics have been disappointing of late. Years of extraordinarily easy monetary policy stoked corporate borrowing and financial engineering, and some companies are now struggling with the increased debt load as revenues and profits begin to roll over (see graph).

Additionally, what is ironic is that while everyone (understandably) focuses on the domestic economic situation, the factor that has opened the door again for the Fed to keep moving rates this year, which seemed impossible only a few weeks ago, is the improvement in financial conditions. That has largely come on the heels of China policy makers making a decision to not aggressively devalue their currency to protect against capital flight, an aggressive ECB, and a stabilization in oil’s persistent price descent. Thus, while we think that the U.S. data is marginally deteriorating, and may continue to do so, we think that financial conditions, including the potential strength of the USD (and its related influence on global growth and corporate earnings), will be one of the primary determinants of whether that door for further Fed moves stays open or gets slammed shut due to global economic/market duress.

Hence, keeping an eye on the Fed for market price-action going forward may also mean keeping the other eye focused outside the U.S., and somewhat outside the Fed’s core dual mandates of employment and price stability. Indeed, the path of monetary policy change in the year ahead may be determined as much by what occurs outside the country’s borders than within them; more so than any time in recent history.