Global Daily: Fed scales back hikes

by: Nick Kounis , Maritza Cabezas , Georgette Boele , Kim Liu


Global-Daily-Insight-16-June-2016.pdf (160 KB)


FOMC communication – The Fed left interest rates on hold on Wednesday and scaled back forecasts for future rate hikes. Fed policymakers still forecast two rate increases this year, but a sizeable minority now see only one. In addition, the FOMC sees a slower pace of rate hikes in 2017 and 2018. This leaves the 2016 federal funds rate stable at 0.9%, while in 2017 it is now at 1.6% (was 1.9%) and 2018 at 2.4% (was 3%). Economic forecasts now show more conservative GDP growth, higher inflation and unemployment practically unchanged. The FOMC statement was balanced. We expect rates to remain on hold this year given moderate underlying economic and job growth and global vulnerabilities. Please see our note here, for more on the June FOMC. (Maritza Cabezas)


Global Markets – The Fed’s more dovish communication resulted in weakness of the US dollar, lower US Treasury yields but higher gold prices and emerging market currencies. Financial markets have further priced out the possibility of even one rate hike this year. The Fed funds future at the end of 2016 now stands at just 0.46%. During the press conference the US dollar recovered somewhat. With our base case of the Fed being on hold this year, the US dollar will likely be under pressure. However, nervousness surrounding Brexit should keep the US dollar and the yen supported in the near-term. Indeed, the more calm mood on financial markets earlier on Wednesday may not last. The ascendancy of the Leave camp seems likely to trigger further nervousness ahead of the referendum. (Georgette Boele)


Government bonds – Due to the recent drop in bond yields, an increasing proportion of government bonds have become ineligible for the ECB’s QE programme. This has refuelled speculation about whether the ECB will be able to buy enough bonds to meet the targets of its QE programme, given its current structure and rules. We think these fears are justified as we calculate that the QE programme could hit its limits even before March 2017. In particular, the ECB will very likely run out of German government bonds (as well as those from Portugal and Finland). In order to create more breathing space, the ECB could change its current rules. Possible options are to remove the deposit rate floor, which does not allow the ECB to buy bonds yielding less than the deposit rate. It could also further increase the issuer share limit or remove the capital key for its purchases. Please see our full note here for more details on this topic. (Kim Liu)