Dovish-light Fed seeks comfort in numbers

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Yesterday’s Federal Reserve Open Market Committee (FOMC) policy meeting provided few surprises, very gently guiding the market towards a possible September rate hike barring any major surprises in the economic data and outlook. This was broadly in line with expectations and my forecast that the FOMC would deliver a dose of boring to a market that had been on tenterhooks (Fed says it best when it says nothing at all, 17 June 2015).

The FOMC kept its policy rate unchanged at 0-25bp, made only minute changes to its inflation and unemployment forecasts, and while it again slightly lowered its appropriate policy rate targets for 2015-2017 the FOMC members showed a greater degree of uniformity in their target rates.

  • For end-2015, the average target rate was cut 20bp to 57bp (slightly more dovish than a recent Bloomberg survey) with the range of responses halved to 75bp (see crosses in Figure 1). Noticeably, the number of FOMC members expecting one hike or less this year jumped to 7 from 3 (out of 17)
  • Similarly, for end-2016 the average target rate was cut 27bp to 1.75% and the range of responses narrowed to only 2.5%

It seems logical that the closer the FOMC gets to the forecast date, the greater certainty of its forecast. The FOMC cut its GDP growth forecast for 2015 more significantly after a disappointing Q1 (see Figure 2) but in its press statement noted the more recent recovery in economic activity. Common sense and a pinch of dovishness, for the next six months at least, therefore seems to have been the order of the day and markets reacted accordingly. US equities and Treasuries closed slightly stronger whilst the US dollar lost further ground.

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Figure 1: FOMC more certain that target policy rate will be lower than previously expected in 2015-2017

That doesn’t mean that it’s necessarily going to be plain sailing over the next three months – even riding a bicycle can be a little nerve-racking after nearly ten years out of the saddle. While the FOMC acknowledged the need for less bullish growth, unemployment and policy rate forecasts for 2015, it kept its projections for GDP growth and the unemployment rate for 2016 and 2017 broadly unchanged (see Figure 2). Actually, if we’re going to be pedantic, the FOMC marginally bumped up its 2016 and 2017 growth forecasts.

The average target level for the policy rate in the longer-run was also unchanged at 3.65% (see Figure 1), implying that the FOMC now believes that a slightly faster pace of rate hikes between 2015 and the longer-run is optimal. To be precise, the FOMC members now on average expect 308bp of hikes between end-2015 and the longer-run, versus 289bp in the March 2015 projections and 265bp in the December 2014 projections. That’s almost an extra two 25bp hikes. Now of course forecasts for the longer-run need to be taken with a large pinch of salt – after all in the long-run we’re all dead as Keynes pointed out.

But what these numbers suggests is that the FOMC expects the same terminal rates for growth, unemployment and inflation albeit from a weaker base (2015) and that consequently this may require a slightly faster pace of rate hikes than previously thought. There is little sense in these forecasts that the long-term equilibrium level of the US economy has been downgraded following the great financial crisis or is prey to international events largely beyond its control. That leaves scope for disappointment and a further market repricing of the Feds’s lift-off date.

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Figure 2: FOMC has a more pessimistic take on 2015 but still bullish for 2016-2017





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