Fed in wait-and-see mode. Within the FOMC there is widespread consensus on 2015 as the year of the first rate hike, but there is great dispersion of opinions on the pace of the hike cycle…
For professional investors and advisers only
The FOMC projects a slightly faster rate path than expected in March, and the estimated neutral rate is slightly lower. The market focused more on the latter than the former, but is likely to adapt subsequently: market complacency is at odds with the improvement of the economy, even though the Fed’s tone remains very dovish.
– The FOMC meeting yielded a statement broadly in line with April’s, and the tapering of asset purchases was confirmed at the consolidated pace. The most important changes regarded the macroeconomic and interest rate projections. The tone of the statement clearly signals the intention to await further data to confirm the positive evolution of the recovery and the building of internal consensus on the exit strategy. More relevant information will emerge from the minutes, which should start to “map” opinions on the policy shift expected to start in 2015.
– In the statement, the FOMC acknowledges the recovery in growth (“economic activity has rebounded in recent months”) and the reduction of the unemployment rate, which nonetheless is considered still “elevated”. The remarks on inflation, that has been “running below the Committee’s longer-run objective” are exactly the same as in the previous statement, despite the recent signals of an acceleration. Putting together the assessment of the economic picture and the new macroeconomic projections, two essential points emerge for the Fed’s policy scenario, on the economy and interest rate scenario.
1) The FOMC’s view on the evolution of the economy is positive. According to Yellen, the Committee remains confident that the contraction in 1Q was transitory, and that economic activity is now on a more sustainable path, expanding at a “moderate pace” following its rebound in 2Q 2014, with faster growth, improving labour market conditions, close-to-neutral fiscal policy, expansive financial conditions, and rising financial and real asset prices. The revision of growth forecasts is limited to 2014 (2.2% at the end of 2014, from 2.9% in March), and for 2015 and 2016 growth rates of 3.1% and 2.75% respectively have been confirmed. Projected growth in the longer run has been reduced slightly, to 2.2% from 2.25%. The unemployment rate is forecast at 6% at the end of 2014, at 5.5% at the end of 2015, and at 5.3% at the end of 2016, with a longer-term estimate of between 5.2 and 5.5%. Inflation projections are broadly unchanged, at 1.6% at the end of 2014, 1.75% at the end of 2015, and 1.8% at the end of 2016.
2) The Fed is, once again, stuck between a rock and a hard place for the definition of its rate strategy, while the outlook is subject to a lot of uncertainty: growth and unemployment projections have, yet another time, been revised downwards together, making it hard to define the interest rate hike path for next year. Yellen said that “there is uncertainty about what the path of interest rates, short-term rates, will be, and that’s necessary because there’s uncertainty about what the path of the economy will be”. The reduction in slack, the modest reacceleration of inflation, albeit not mentioned in the statement, and the downside revision of longer-term growth, have resulted in changes in the “dot plot”. For what concerns rate forecasts, FOMC consensus continues to point to a reversal in 2015, with 12 participants who believe it is appropriate to hike rates in 2015, one in 2014, and three in 2016. As regards the longer term, the expected end point has been lowered, to 3.75% from 4%: this is the aspect on which the markets focused most in fuelling the post-meeting rally. In between the first hike and the and the end point, other notable aspects are that the pace of the rate hikes has been stepped up, and forecast dispersion has increased significantly.
– The minutes, to be published in 3 weeks’ time, should shed some light on the opinions held by FOMC participants, even if on the whole consensus should emerge over the fact that the interest rate path is highly uncertain and will depend on the evolution of the economy, and in particular on slack (distance from the maximum employment target) and inflation (distance from the 2% target). For the time being, the market remains highly complacent, and persuaded that the pace of the rate hikes will be very gradual (fed funds future December 2015 at 0.72%, December 2016 at 1.82% following the meeting). Our forecast is that the point of arrival will be lower than in the past, whereas the cycle will be a little faster than priced in by the market, both in 2015 and 2016.
Appendix
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