- Fed set to remove ‘patience’, but inflation outlook key for June rate hike
- we think that the Fed’s view on unemployment remains solid, view on long term inflation unchanged
- ECB running ahead of targets for purchases in first few days of QE
Fed will lose patience, but remain calm
On Wednesday the FOMC will conclude its policy meeting. FOMC members will provide additional guidance about the timing of the next rate hike. We expect the FOMC to drop the term ‘patient’ from its statement as an indication of how long it plans to wait before raising interest rates. However, Chair Yellen in her testimony to the Senate said that modifying this guidance “should not be read as indicating that the FOMC will necessarily increase the target range in a couple of meetings”.
Rate hike in June, some downside risks
We think that the FOMC will start hiking interest rates in June, but there is a risk of a delay if soft economic data were to persist or if core inflation were to undershoot our expectations. Indeed, the FOMC could approach the rapid pace of appreciation of the USD and the diverging monetary policies of other central banks by reflecting a more gradual pace of rate hikes in the “dot charts” that include participants median view on the outlook for policy rates.
FOMC softer view on economy, while unemployment solid
During this meeting the Summary of Economic Projections will be released. Despite the continued improvement in the labour market, the US economy has had a slow start to this year. We expect the Fed to soften its assessment of the economy and to mark down slightly the GDP growth path. However, the unemployment rate projection will likely be lowered, as a result of the stronger than expected labour market conditions.
FOMC view on long run inflation unchanged
We think that FOMC members will remain relatively confident about the long term inflation outlook. Chair Yellen mentioned to the Senate that FOMC members “expect inflation to decline further in the near term before rising gradually toward the Committee’s 2% objective as the labour market improved further and the transitory effect of lower energy prices and other factors dissipated”. We expect core inflation to increase gradually in the second half of the year, reaching the 2% target in 2016. This is in line with the Fed’s objective.
ECB running ahead of targets for QE purchases
The ECB published amounts of settled purchases under its QE programme last week. The Public Sector Purchase Programme (PSPP) – which includes government bonds and securities issued by national and European institutions – purchased a total of EUR 9.75bn. This total only includes the purchases made in the first three days of last week, as purchases made on Thursday and Friday have not settled yet. This means that the programme is so far running at a purchase rate of EUR 3.25bn per working day. This is above the EUR 2.4bn we estimate would be necessary to hit the announced targets.
More difficulty after low hanging fruit
It is of course very early days and the ECB and national central banks may be building in some breathing space for later. It is likely that the purchases will be easier in the first few months of the programme, as the central bank can benefit from low hanging fruit. However, the demand-supply balance for high quality securities is already very tight and will become tighter. Regulations mean that financial institutions not only want to hold to their bonds, but in some cases want to add to them. The entrance of the ECB is adding a big new buyer and this will create a scarcity of core government bonds. We expect the ECB to hit its purchase targets, but it will have to pay high prices. This will keep core bond yields depressed.