Federal Reserve: Setting the stage for a rate hike in September

Transcription

1 Policy Watch: US Federal Reserve Treasury Research Group For private circulation only Federal Reserve: Setting the stage for a rate hike in September Chart: Probability of 2 more rate hikes in 2018 remains fairly high Note: Derived from the Fed Funds Futures market Source: Bloomberg and ICICI bank Research The Federal Reserve stuck to the script maintaining status quo on expected lines. The modest changes made in the policy statement reflect the FOMC s continued confidence in the state of the US economy. Hence, another 25 bps rate hike in September-2018 remains on the cards followed by a fairly high probability of another 25 bps rate hike in December The USD remained flat and is showing some signs of fatigue given that US outperformance and the Fed s rate hiking trajectory has been more or less priced in. However, trade-war fears and a continued uptrend in the USD/CNY could in turn provide some support to the USD in the near-term. The US yield curve steepened more as a response to the treasury refinancing program announcement for H22018 than to the FOMC statement. We expect the 10-year US sovereign yield to trade higher. However, the steepening bias in the curve is unlikely to persist. Policy statement: Modest changes made August 2, 2018 Shivom Chakravarti shivom.chakravarti@icicibank.com Tel no: Ramakrishna Reddy Bogathi ramakrishna.bogathi@icicibank.com Tel no: Please see important disclaimer at the end of this report The Federal Reserve maintaining status quo was on expected lines given that it has already hiked rates by 25 bps in the previous policy in June There were some modest changes made that reflect the FOMC s continued confidence in the state of the US economy: Economic activity was described to be rising at a strong rate compared to solid rate in the previous statement. The unemployment rate was described as being low versus declined previously. Core inflation was described as remaining near 2% as against moved closer to 2% previously. Risks to the economic outlook continued to be described as roughly balanced and inflation near the FOMC s symmetric 2% objective over the medium term was maintained. The statement that the committee expects that further gradual increases in the target range for the federal funds rate was maintained. The stance of monetary policy continued to be described as accommodative. In short, the developments in the real economy made the Fed stick to its gradual tightening path as it set the stage for additional rate hikes. The lack of an explicit mention of trade-wars and financial market volatility suggest that the Fed does not see these two factors as significantly weighing on outlook of the US economy at the current juncture. While there could be some moderation due to base effects and pull-back in exports in Q32018, US growth is likely to remain firm and output gaps are likely to remain positive over A robust labour market is likely to ensure that income growth remains positive supporting consumption in the process and first round effect of fiscal stimulus delivered in 2017 is likely to emerge as another important support. We subsequently expect the Federal Reserve to tighten policy by 25 bps in September and assign a fairly high probability of another rate hike of 25 bps in December The Fed funds futures market is already pricing in close to 80% probability of a 25 bps rate hikes in September.

2 Market implications: It s in the price The Dollar index (DXY) remained unchanged in response to the policy statement given that it came in line with expectations as the Fed stuck to the script. While we continue to see some support for the USD, we take note of the fact that there does appear to be some fatigue setting into the FX markets as the DXY has not been able to break convincingly higher over the last fortnight. A key reason for this is that on a positioning front the market has already gone fairly long on the USD as US economic outperformance and the Fed s tightening path appear to be priced in. Hence, markets are waiting for a fresh set of triggers. In that regard, we think that the trade battle will likely emerge as an important near-term driver. The US government is expected to move ahead with its protectionist stance against China that could invoke another round of uptrend in the USD/CNY pair and risk aversion that might provide some more near-term support for the USD. However, the good news from the US economy appears to be in the price and only adverse developments or dovish statements from the non-us G-10 central banks are likely to emerge as the main catalysts for further USD uptrend. Another important development has been the US Treasury announcing its refinancing program for H It is worth noting that the funding for H22018 is estimated at USD 770 billion that would be the highest figure since H22008 during the financial crisis when the funding was around USD 1100 billion. Rising US treasury issuance at a time when US growth is strong is unlikely to derail the USD. However, that could change if US growth starts to disappoint. At the current juncture, that does not seem likely. While the effect of the US treasury program announcement on the FX market was limited, US yields particularly at the longer-end have moved higher resulting in a steepening of the yield curve. The steepening took place because the issuance announced at the longer-end was above expectations and the issuance announced at the shorter-end was similar to that seen in H We expect the uptrend in US yields to continue driven by the twin factors of gradual monetary tightening and increase in the supply of paper with the US 10 year sovereign upside potential of around 3.05%. However, the shorter-end is likely to move higher as markets continue to price in more rate hikes by the Federal Reserve in response to US data flow confirming the market s expectations of more rate hikes in store. This should result in the yield curve flattening somewhat after the brief phase of steepening. 2

3 Growth FOMC statement comparison June 13th, 2018 August 1st, 2018 Our assessment The labor market has continued to strengthen and that economic activity has been rising at a solid rate. The labor market has continued to strengthen and that economic activity has been rising at a strong rate. Mildly Hawkish Labour market Job gains have been strong, on average, in recent months, and the unemployment rate has declined. Job gains have been strong, on average, in recent months, and the unemployment rate has stayed low. Other sectors Recent data suggest that growth of household spending has picked up, while business fixed investment has continued to grow strongly. Household spending and business fixed investment have grown strongly. Mildly Hawkish Inflation On a 12-month basis, both overall inflation and inflation for items other than food and energy have moved close to 2 percent. Indicators of longer-term inflation expectations are little changed, on balance. On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance. Risk to the outlook The Committee expects that further gradual increases The Committee expects that further gradual increases in the target range for the federal funds rate will be in the target range for the federal funds rate will be consistent with sustained expansion of economic consistent with sustained expansion of economic activity, strong labor market conditions, and inflation activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective near the Committee s symmetric 2 percent objective over the medium term. Risks to the economic outlook over the medium term. Risks to the economic outlook appear roughly balanced. appear roughly balanced. On Fed funds rate In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-3/4 to 2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation. In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1-3/4 to 2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation. Voting Voting for the FOMC monetary policy action were Jerome H. Powell, Chairman; William C. Dudley, Vice Chairman; Thomas I. Barkin; Raphael W. Bostic; Lael Brainard; Loretta J. Mester; Randal K. Quarles; and John C. Williams. Voting for the FOMC monetary policy action were: Jerome H. Powell, Chairman; John C. Williams, Vice Chairman; Thomas I. Barkin; Raphael W. Bostic; Lael Brainard; Esther L. George; Loretta J. Mester; and Randal K. Quarles. 3

4 ICICI Bank: ICICI Bank Towers, Bandra Kurla Complex, Mumbai Phone: (+91-22) Treasury Research Group Economics Research Kamalika Das Economist (+91-22) (ext 6280) Shivom Economist (+91-22) (ext 6273) Chakravarti Anushri Bansal Economist (+91-22) (ext 6220) Sumedha Economist (+91-22) (ext. 7243) Dasgupta Ramakrishna Economist (+91-22) (ext. 6943) Reddy Bogathi Ashray Ohri Economist (+91-22) (ext. 7249) Pradeep Kumar Economist (+91-22) (ext. 6272) Yash Panjrath Economist (+91-22) (ext. 8161) Sparsh Chhabra Economist (+91-22) (ext. 7309) Treasury Desks Treasury Sales (+91-22) Currency Desk (+91-22) Gsec Desk (+91-22) FX Derivatives (+91-22) /43 Interest Rate Derivatives (+91-22) Commodities Desk (+91-22) Corporate Bonds (+91-22)

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