- We now expect first Fed rate hike in September and a more gradual pace of hikes in 2016
- New EUR/USD forecasts: 0.95 end of 2015 and 1.10 end of 2016
- Lower euro triggers upward adjustment to eurozone 2015 GDP growth forecast
Change in fed funds forecast…
Following the FOMC meeting on Wednesday, we have revised our view of the timing and pace of Fed rate hikes. We now think the FOMC will hike rates in September, rather than June. We also now expect the federal funds rate will rise to 0.75% at year-end 2015 and to 2.25% at year-end 2016. This means a hike every other meeting starting in September 2015. Then the pace of rate hikes increases in the second half of 2016 to every meeting. We previously expected the fed funds rate to reach 1% at the end of 2015 and 3% at the end of 2016.
…driven by a more cautious FOMC
This revision responds to the more cautious tone of the FOMC statement and their downward revisions to GDP growth and inflation. We recently also lowered our GDP growth for 2015, though we maintained our forecast for 2016. In line with the tone of the statement, the individual interest rate forecasts of FOMC members for the fed funds rate, released together with the statement, showed a lower interest rate path, suggesting that a delay in the rate hike is more likely. Overall, we think that the Fed remains confident enough in the outlook to hike rates this year, but the softer growth forecast and stronger dollar, suggest it will be more cautious.
New forecasts for EUR/USD
Indeed, the dollar’s strength has even surpassed our expectations. In particular, the drop in EUR/USD has run at a much higher pace that we had foreseen. As a result, our EUR/USD forecast for the end of the year of 1.05 was reached last week. Despite the strong US dollar rally, we still expect another 10-15% rise. This move will likely come earlier. Our new EUR/USD forecast for the end of 2015 is 0.95. However, we now expect it to rebound to 1.10 by the end of 2016.
What is behind our dramatic change in forecasts?
The underlying momentum in the US dollar rally is very strong. This is reflected by the substantial recovery after the sell-off following the Fed meeting. In addition, we continue to expect more rate hikes in 2015 and 2016 than financial markets currently anticipate. This is because of our above consensus call on the US economy. We therefore expect markets to adjust their US rate expectations up as the prospect of a September hike becomes more concrete. Therefore, we expect most of the US dollar strength versus the euro in 2015. In contrast, we now expect a recovery in EUR/USD next year. This is because stronger eurozone economic recovery and a pick-up inflation will probably result in financial markets starting to price in a tapering from ECB QE next year. This should push the euro higher.
Positive impact on the eurozone economy
Our scenario for the eurozone economy was already based on a sharp depreciation of the effective euro exchange rate. Still, the changes to our EUR/USD scenario shift the positive impact of the drop in the euro on GDP growth a few quarters forward. This means that, on balance, net exports contribute a couple of tenths of percentage points more to growth this year than we estimated before. Consequently, we have raised our GDP growth forecast for 2015 to 1.8% from 1.6%. Due to statistical overlap effects, and because changes in the exchange rate work their way through the economy with a delay, our forecast of 2016 also rises a touch (to 2.3% from 2.2%). We were already above consensus and we now have an even a more positive outlook.