FOMC: “caution is appropriate” on an even more gradual rate hike path. The message sent by the FOMC March meeting is dovish on the whole, but also confirms flexibility in the face evolving data and financial conditions. Volatility is assured for the rest of 2016…..
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Intesa Sanpaolo – Research Department For professional investors and advisers only
The March FOMC meeting ended reasserting confidence that both the maximum employment and 2% inflation goals will be achieved by means of an appropriate rate hike path. The main indication which emerged from the meeting is contained in the dot plot, which reduces the expected rate hikes in 2016 (from 4 to 2), confirms 4 in 2017, foresees 5 in 2018, and lowers the neutral rate level to 3.25% from 3.5%. The decision on rates was opposed by George (Kansas City Fed), who was in favour of a 25bps hike.
In the statement, the overall picture of the US economy remains positive and in line with the scenario outlined in January, “despite the global economic and financial developments of recent months”. In March, as in January, no overall assessment of risks is offered: the forecast is for the recovery to continue, although the statement warns that “global economic and financial developments continue to pose risks”. The Committee intends to gather further information on the global scenario, and continues to see danger in the tighter financial conditions seen since the beginning of the year, despite the recent waning of this trend.
In its macroeconomic projections, the FOMC marginally lowered forecast growth at the end of 2016 (to 2.2% from 2.4%) and in 2017 (to 2.1% from 2.2%). The unemployment rate is forecast to drop further, to 4.5% in 2018 (two tenths below the previous projections); the longer term unemployment rate is dropped to 4.8% from 4.9%. As for core inflation, the PCE deflator is still forecast at 1.6% at end-2016 (a level already reached in January), and the forecast for 2017 is lowered to 1.8% from 1.9%; the 2% target should be hit in 2018.
In the dot plot, the lower median projection for 2016 of only two hikes hides a dispersed distribution: nine participants expect rates no higher than 0.875%, but eight project rates above that level (i.e. three and four hikes). This signals relative “instability” of the median projection, which could shift back upwards, with only one participant changing stance. The median forecast for 2017 is for four hikes following the move in 2016, whereas in 2018 the median points to five hikes (in December, the median was four hikes). It is essential to take the dot plot for what it is: a rough indication of the path, which may shift “discretely” with the evolution of data. The other important factor is that there is widespread consensus on two hikes. A single hike is unlikely: the FOMC intends to overshoot its goals, but there are signals of an overheating in some segments of credit markets (car loans and commercial real estate, for instance) which should not be undervalued.
The essence of the message of the March meeting lies in Yellen’s statement that “caution is appropriate”, given the host of external risks weighing on the scenario, which make the monetary policy path uncertain. Yellen also emphasised that the projections contained in the dot plot are the best possible, but do not represent “a predetermined plan, a commitment, or a promise”. During her press conference, Yellen made a positive assessment of the economic scenario, while pointing out lights and shades: on-going improvement of the labour market, but slightly weaker growth and a still moderate wage trend, inflation on the rise, but still not free from the downside pressures exerted by the exchange rate and oil prices.
The March meeting confirmed that the Fed’s monetary policy is truly data-dependent, and that guidance in the present phase of the cycle can only be indicative, as the scenario is intrinsically uncertain. The result is also, as we have seen in recent months, high volatility on the markets. It is also important to note that the uncertainty weighing on the scenario is compatible with positive surprises, as well. On the whole, however, the behaviour of the FOMC seals Yellen’s opinion that recoveries do not die of old age, and may be kept in good health with appropriate monetary policies, as long as there are no internal imbalances. This is effectively the case for the US economy in 2016: long live the recovery!
Source: BONDWorld.ch
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