- FOMC strikes a dovish tone but continues to signal rate hike this year
- Our view is that a rate hike in December remains likely…
- …but concerns about the global economy suggest that risks of a delay to 2016 are now larger
Financial turmoil puts FOMC on hold
After two days of meetings, the Fed kept rates on hold. The FOMC statement showed that policymakers are concerned about recent global developments and the tightening of financial conditions and their impact on economic activity. However, the door was left open for a rate hike this year. During the press conference, Chair Yellen mentioned that every remaining meeting this year remains a possibility for a move. However, FOMC members would like to see the extent to which these developments have impacted the US economy given the strong financial interconnectedness. FOMC members also want to see further improvement in the labour market, particularly a recovery in part-time involuntary employment and labour force participation. This suggests that October is too early and that risks of a delay of a rate hike to 2016 have increased. We expect a rate hike in December as global risks should ease and the US economy should continue to recover.
FOMC forecasts: no urgency for rate hike
The Summary of Economic Forecasts, painted a mixed picture. In the short run, slightly weaker growth but lower unemployment, while inflation was lowered. At the same time, the long-term outlook was not fundamentally altered. In 2015, GDP growth edges up to 2.1% from the 1.9% projected in June, while for 2016, the Fed lowered its GDP forecast to 2.3% from the 2.5% projected in June. Long run growth was unchanged. Meanwhile, the unemployment rate forecasts are now closer to the long run projection of 5%. As for inflation, the forecasts showed “reasonable confidence” that inflation would move back to the 2% target.
Dot plot shows interest rate hike this year
The “dot plot” which shows participants views on the appropriate pace of interest rate normalisation shows that FOMC participants expect the lift off this year. However, four members feel that the Fed should not hike until 2016 or later. The long run projection of the federal funds rate was lowered 25bp to 3.5%, reflecting the slightly more cautious tone of the Fed. One of the members wanted negative interest rates, suggesting that the economy needed further stimulus.
Markets were volatile following the decision, but overall outcomes were supportive for bonds and gold, but negative for the dollar, as markets scaled back rate hike expectations. Gold prices moved higher, while the US dollar and 10y US Treasury yields fell. At the end of the session US equities gave up their gains and closed down for the day. If the Fed eventually hikes in December as we expect, then the US dollar and yields should move up, while gold prices are likely to fall back. The EUR/USD should also be pushed down by a stepping up of ECB QE.