- FOMC removes ‘patient’, but downgrades view on economic outlook…
- …while central view of policy rate trajectory has also moved down
- Chances that Fed will wait beyond June to raise interest rates have increased
- After lift-off, it seems likely that rate hikes will be moderate
FOMC removes ‘patient’, but is not in a hurry
After a two day meeting, the FOMC dropped “patient” from the guidance in its statement and added that an “increase in the target range for the federal funds rate remains unlikely at the April FOMC meeting”. This change gives FOMC members more flexibility in determining the timing of rate hikes, but it also signals that they are sticking to their plan to hike rates this year. Chair Yellen mentioned several times that she is looking for further improvement in the economy and labour market before starting to raise the policy rate. These conditions would be necessary to have “reasonable confidence” that inflation will move towards the 2% target.
More cautious tone on US economy…
Fed policymakers downgraded their view on the economic outlook, as a result of the weaker incoming data in the first quarter. They replaced in the statement that ‘economic activity is expanding at a solid pace’ by ‘economic growth has moderated somewhat’. A strong dollar and lower energy prices have resulted in weaker export growth and inflation declining further below the Committee’s longer run objective. The Summary of Economic Projections for 2015 cut midpoint GDP growth by 0.3pp to 2.5% and inflation by 0.6pp to 0.7%. Growth, however, is still seen at above trend rates in the coming years, while inflation returns to 2% in the long run. The unemployment rate was lowered by 0.15pp to 5.1% in 2015.
…leads members to plot a lower interest rate path
The FOMC lowered its projected interest rate path. The median projection of the fed funds rate fell 50bp to 0.625% end 2015, and fell 62.5bp to 1.875% at end 2016 and 50bp to 3.125% at end 2017. Only two participants again indicated that the first rate hike should be delayed until 2016. All in all, the Fed statement shows that FOMC members will be data dependent but are tending towards a slower pace. The chances that the Fed waits beyond June (our current base case) to raise rates have clearly increased. In addition, the rate hike cycle looks likely to be slow once it does start.
Markets rejoice on Fed’s caution on rate hikes
Financial markets cheered the FOMC statement and Yellen’s testimony. The interest rate implied by the Fed funds future dropped considerably to 0.4% at the end of 2015 (-10bp) and to 1.15% at the end of 2016 (-20bp). Most asset classes loved the idea of slower rate hikes, except of course the US dollar. US equity markets showed substantial gains. US Treasury yields dropped (10y -14bp). Most commodity prices more than recovered the weakness seen earlier in the day. For example gold, silver and oil prices rallied by 2-4%.
Dollar weakness likely temporary
The US dollar dropped sharply. This was reflected by EUR/USD popping above 1.0850. The weakness in the US dollar is not unusual after the substantial rally seen since July 2014. This weakness is not a change in direction, but a temporary move in our view . The Fed’s new forecasts are still consistent with significant monetary policy divergence with the rest of the world.