Although the FOMC statement emphasised that a rate hike is not imminent and when tightening eventually starts the pace will be slow, a slightly higher median forecast for the fed funds rate was a surprise to us and obviously also to financial markets, triggering higher USD rates and a stronger USD.
Thus, while the median FOMC projection for the fed funds rate was unchanged 0.25% by end-2014, it was raised from 0.75% to 1.0% by end-2015 and from 1.75% to 2.25% by end-2016. Of the 16 participants at today’s policy meeting, 13 expected that it will make sense to start raising rates in 2015 (see chart).
The projections still show the fed funds rate remaining extremely accommodative even by the end of 2016, even though the economy is believed to back at full employment at that time. According to the statement, “economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.” The Fed sees a 4% interest rate as being neutral/normal in the long-run.
We continue to believe that the Fed eventually will hike rates faster than currently priced in financial markets. Tomorrow we will release an in-depth analysis on slack in the labour market and argue why we believe the Fed is underestimating inflation risks.
As widely expected, the Yellen-led Fed decided to continue tapering the pace of asset purchases by a further USD 10bn, to USD 55bn per month, sticking to the course outlined by Bernanke in December. The Fed indicated that as long as the economy improves as expected, it will continue reducing the pace of purchases by USD 10bn at every FOMC meeting. We continue to expect QE to end in October.
In line with our expectations the Fed also dropped its threshold forward rate guidance. Going forward, the Fed will look at a broader array of indicators in deciding when to start raising short-term interest rates, including labour market conditions, inflation and financial conditions. The move to qualitative guidance makes the so-called “dot chart” with each FOMC participant’s projection of the appropriate funds rate path even more important for the markets.
Also in line with expectations, there were only minor tweaks to the economic outlook paragraph in the FOMC statement. The statement said economic activity had slowed during the winter months, but blamed the slowdown in part on “adverse weather conditions.”
Its longer-run projections for GDP growth, inflation and unemployment were also little changed, with slightly lower growth and unemployment forecasts. The Fed sees the jobless rate hitting 6.1% to 6.3% by the end of the year, lower than the December projection of 6.3% to 6.6%.
Nordea