US Outlook Report: FOMC Scales Back Rate Hike Expectations
The large gap between the Federal Open Market Committee’s Fed funds target rate expectations and the market’s own projections about the future path of the Fed’s rate policy closed rapidly this week and it wasn’t the market adjusting to the Fed, it was the Fed bringing its views more in-line with the market.
The gapping difference between the FOMC’s December ‘dot-plot” of where each of 17 FOMC market participants saw the Fed funds rate at the end of 2015, 2016, and 2017 and the market’s view was never resolved. Such a wide and persistent difference in FOMC and market guidance on policy rates has never been seen before. Clearly, something had to give. Either market rates needed to move much higher in a very short-period of time, potentially upsetting a relatively sanguine economic outlook, or the FOMC would need to rethink the December ‘dot-plot”. And re-think they did.
Today, there is much more agreement between the FOMC “dot-plot” and the futures market expectations on the Fed funds interest rates over the next three years – but not total alignment. By the end of 2017, the FOMC median sees the Fed funds rate at 3.125%, while the futures market expectation is still 1.4 percentage points below that level at 1.73%.
The FOMC blinked a bit, giving in to the market guidance on interest rates. Increasing concern about the rising dollar was evident in the March FOMC statement with the mention of weak export growth. It is harder for the Fed to raise interest rates in a world where the other major central banks are going in the other direction. According to Bloomberg, 24 global central banks have eased monetary policy in the first quarter of 2015. The global rate and currency divergence has only intensified with the launch of the ECB’s QE program in March. German 10-year Bund yields slipped to just 0.185% yesterday with U.S. 10-year Treasury rates holding at 1.96%.
With global oil prices yet to find a bottom, low inflation could remain longer than currently appreciated. Just in the last five days alone, WTI crude oil prices fell more than 6%. In fact, low inflation in the U.S. is already raising real interest rates in the United States without the Federal Reserve having to lift a finger. The real Fed funds rate has risen nearly 2.0 percentage points since October.
While the first rate hike from the Fed could theoretically come in June, September is looking more likely now given the revised “dot-plot” guidance from the Fed. Beyond liftoff, rate hikes are expected to continue at a gradual pace- about half the pace seen in recent tightening cycles.
To find out more, check out this week’s US Outlook Report.
Tags: economy