Fed: The Devil is in the Detail
The Fed left rates unchanged, leading us to expect three rate hikes this year.
The FOMC holds eight regularly scheduled meetings during the year to decide its monetary policy. Only four of the meetings are followed by a press conference, in March, June, September and December, giving them arguably more prominence.
The conclusions of the 2 May meeting were therefore communicated via a press release only, which generally does not encourage the Fed to take major decisions since there is no opportunity to explain them to the market afterwards. This meeting will not have escaped this rule, in the sense that monetary policy has remained unchanged; by unanimous decision, the range of key rates remains at 1.50%-1.75%.
That said, two points are interesting to note.
Inflation closer to target
The Fed is much more confident about the inflation path. It no longer says that it will closely monitor price developments. It now sees inflation on an annualised basis approaching its target of 2%, both for headline inflation and for inflation excluding food and energy prices. For the first time, the Committee talked about a "symmetric" inflation target, implying that it will also tolerate inflation slightly above target.
The US economy is strong
The Fed believes the economy remains strong, especially investment, and the job market is dynamic. On the other hand, consumption showed signs of weakness in the first quarter.
Anticipation of the rate trajectory
Recent market data showed that inflation has been accelerating for several months, driven by rising oil prices, a weak dollar, trade war concerns and wage increases. Thus, the PCE (Personal Consumption Expenditure) index that the Fed follows closely shows that inflation reached 2.0% in March and inflation excluding food and energy prices rose to 1.9%. The market is therefore anticipating a 25bps increase in rates in June, and expects a second rise in rates before the end of the year, which is in line with the forecasts issued by the Fed in March.
We think the Fed could go further and raise rates three times by the end of the year: in June, September and December. This seems more consistent with macroeconomic data and the analysis of individual Fed members' speeches and projections. Indeed, whilst the projections of the Committee are made by voting and non-voting members, this year it’s the voting members who are more inclined to raise rates. Fed fund rates could therefore be raised to 2.25%-2.50% in December. Looking forward, we anticipate only one rate increase in 2019 because economic activity should slow down. The terminal rate would therefore be 2.75%. As for the Fed, it anticipates three interest rate increases in 2019 and two in 2020, which sets the Fed funds at 3,375% but the longer term rate drops to 2.875%.