Global Daily – Fed: case for rate increase in December strengthens

by: Maritza Cabezas , Georgette Boele

FOMC communication: A rate hike in December seems likely but lower future path -The Fed left interest rates on hold today as expected. Although the FOMC signalled a December hike, it ultimately re-assured markets (see below) by scaling back forecasts for future rate hikes. Indeed, the majority of Fed policymakers (seven) forecast one rate increase this year. However, this masked a range of views. The dot plot showed that three members think two rate hikes would be appropriate and one even three, while three others expect no rate increase this year at all. Furthermore, three dissenters – Esther George, Loretta Mester and Eric Rosengren – voted for an immediate hike. The unusual large number of dissenters is a sign of a divided Fed and reflects Chair Yellen’s difficulty in building consensus. Meanwhile, the FOMC sees a slower pace of rate hikes in 2017 and 2018. In 2016 the federal funds rate is now seen at 0.6% (was 0.9%), while in 2017 it is now at 1.1% (was 1.6%) and 2018 at 1.9% (was 2.4%). The long run federal funds rate was also lowered, suggesting that the Fed continues to scale back its view of where interest rates will ultimately end up. Furthermore, the forecasts now show lower GDP growth in 2016 and inflation and unemployment practically unchanged through 2018. After a weak first half of the year, we expected that Fed members would revise downwards the GDP forecast for 2016. (Maritza Cabezas)

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Chair Yellen’s press conference: Economy needs more room to run – By reducing the path of rate hikes again, Chair Yellen mentioned in the press conference that this would give the economy “a little more room to run”. Although the economy was performing well, she suggested that most members thought it would be appropriate to give the Fed more time to see how the economy develops. Chair Yellen, signalled that higher growth and lower unemployment would result in a higher neutral rate. She suggested that the low GDP growth forecasts of FOMC members was the result of weak labour productivity growth. However, despite this slow growth, the solid labour market would be the driver for higher inflation. Her press conference showed the challenge faced by Fed Chair Yellen in balancing divergent views. Overall, we continue to expect a rate hike in December and two rate hikes in 2017.(Maritza Cabezas)

Global Markets: Fed re-assures – Initially after the Fed monetary policy decision we saw higher US Treasury yields and a higher US dollar mainly because of the news that three officials dissented and favoured a rate hike. Quickly afterwards, financial markets changed course. Investors viewed the overall message as being more dovish than expected because of the downward adjustments in the dot plot. The fact that the Fed moved into the direction of the market once again was taken as positive sign. As a result, US Treasury yields and the US dollar moved lower, while equity and gold prices rose. Going forward, we doubt that this outcome will lead to a major directional shift in markets. We expect more range trading for the remainder of this year. EUR/USD will likely stay around 1.10 in the near-term while we expect gold prices to stay within in USD 1,300 to 1,350 per ounce range. We also think 10y Treasury yields will end the year not far off current levels. (Georgette Boele)