FOMC: Even more gradual rate path, but the next hike is getting closer – Rabobank

Philip Marey, Senior US Strategist at Rabobank, notes that as widely expected, the FOMC kept the target range for the federal funds rate at 0.25-0.50% today but Esther George (Kansas City), who has become the most visible hawk this year, repeated her dissenting vote because she remains ready to hike by 25 bps.

Key Quotes

“However, this time she was joined by Loretta Mester (Cleveland) and Eric Rosengren (Boston), showing that momentum for a hike is building in the Committee. Nevertheless, the band (Earth, Wind & Fire) plays on and the dance of hawks and doves continues.

The median of the rate projections for this year reveals that the Committee now expects to hike only once this year, instead of twice in the previous projections in June. In line with this rate outlook, the projections for 2016 GDP and PCE inflation were revised downward, and unemployment was revised upward.

The median for the rate trajectory beyond 2016 was revised downward as well. The FOMC now expects only 2 rate hikes in 2017. In contrast, back in June they expected 3 in 2017. The Committee still expects 3 hikes in 2018. For the first time the projections included 2019 and the FOMC expects 3 hikes in that year, ending at 2.6%. What’s more, the longer run equilibrium for the federal funds rate was revised downward to 2.9% from 3.0%.

In other words, the Fed has become even more ‘gradual’ in its hiking plans. Note that the projections suggest that the hiking cycle will end in 2020.

For the time being

• The FOMC statement and Chair Yellen’s press conference were also preparing the markets for a hike later this year. The FOMC thinks that the data show that ‘growth of economic activity has picked up from the modest pace seen in the first half of this year.’

• While the statement acknowledges that the unemployment rate is little changed in recent months, it stresses that job gains have been solid, on average. She also stressed the asymmetry in policy response with the fed funds rate close to zero, which explains the cautious approach.

Next

• There are only two meetings left in 2016. The next takes place on November 1-2. However, hiking for the first time in almost a year less than a week before Election Day (November 8) may evoke political repercussions (although at the press conference Yellen stressed the Fed’s independence of partisan politics). What’s more, the outcome of the elections may in itself pose a risk to the Fed’s outlook for the economy. Also note that this meeting does not have a press conference to explain the decision in more detail than a formal statement.

• Nevertheless, if economic growth picks up, slack in the labor market diminishes, and inflation rises, we expect the Fed to squeeze in one rate hike before the end of the year. After all, the Fed still likes to think that it is on a hiking path. This makes December the most likely outcome.”