Global Daily – Fed preview: Yellen tiptoes to rate hike

by: Maritza Cabezas , Aline Schuiling

Global-Daily-Insight-17-June-2015.pdf (86 KB)
  • FOMC statement set to adopt more positive tone on economy…
  • … paving the way for a rate hike in September
  • Economic sentiment in Germany hit by Greece and higher bond yields



More positive tone FOMC statement

The FOMC statement on Wednesday will likely adopt a more positive tone, reflecting the improvement in the economy, particularly the labour market and consumption in recent reports. Meanwhile, PCE inflation, which is the preferred measure of the Fed has been soft lately. Nonetheless, other inflation measures, including core CPI inflation, have been slowly picking up. The references to inflation should remain broadly unchanged.  Chair Yellen has said that the Fed can hike rates even if inflation is not rising.

FOMC forecasts: some downward adjustments

As for the FOMC forecasts, GDP growth could be lowered as a result of the weaker first quarter growth. However, forward looking data on the labour market suggest that unemployment could also be adjusted downwards somewhat, while we expect inflation forecasts to be broadly unchanged. The long-term GDP growth forecasts will likely be lowered in line with the ongoing weak productivity. We don’t expect major changes in employment and inflation forecasts in the long term.

Dots will continue to reflect different views

The discussions on the timing of a rate hike within the Fed, however, remain complex. On the one hand, we perceive that Board members (such as Chair Yellen, Vice Chairman Fischer) are in favour of a lift-off this year, but some Committee participants have taken a more dovish tone after the weak first quarter economic data, asking more time for data to confirm the improvement in the economy. This suggests that the broad dispersion in the dots will remain broadly unchanged. Nevertheless, we think that most participants will continue to support at least one rate hike this year.

Economists expect September, but markets sceptical

The FOMC has said that its decision to hike rates is data dependent. As a result, the positive data has made economists more confident about a September rate hike. On the other hand, futures markets are still not fully pricing in such a move. In any case, the Fed has recurrently communicated that it is mindful of the possibility of volatility as markets adjust to a change in policy stance.


Economic sentiment in Germany hit by Greece and higher bond yields

Germany’s ZEW economic sentiment fell from 41.9 in May to 31.5 in June. The outcome was well below the consensus forecast of 37. The decline in June followed a 11.4 point drop in May, and it is probably related to rising worries about Greece, which also has hit financial markets. That said, the rise in bond yields in recent weeks has also had a downward impact on sentiment. On balance, a larger share of the respondents of the ZEW survey expect German 10y government bond yields to rise further.

ZEW still consistent with ongoing recovery, but emphasised risks

At its current level ZEW sentiment still is above its long-term average of around 25 and consistent with ongoing growth of the German economy. Still, the drop in sentiment illustrates that the eurozone economy as a whole is feeling the negative effects of the tensions surrounding Greece. Consequently, the ZEW survey emphasises the risks to our scenario of a marked pick-up in economic growth in the coming quarters.