FOMC preview: Status quo with re-affirmation of a tightening path

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1 In Focus: US Fed Treasury Research Group For private circulation only FOMC preview: Status quo with re-affirmation of a tightening path July 31, 2018 Shivom Chakravarti shivom.chakravarti@icicibank.com Tel no: Ramakrishna Reddy Bogathi ramakrishna.bogathi@icicibank.com Tel no: We expect the Fed to maintain status quo at the conclusion of the FOMC meeting on 1-August The Fed is likely to make an upgrade to its growth outlook in the statement taking into account recent developments and reiterate the Fed s commitment to a gradual rate hiking path. The outlook on inflation is likely to be kept unchanged. The Fed reaffirming that it is prepared to tighten is expected to keep the USD supported and result in continued flattening of the yield curve. Fed to keep rates on hold but upgrade its assessment on growth The Federal Reserve is expected to maintain status quo at the conclusion of the July 31-August-1 FOMC meeting given that it hiked rates in its previous policy meet in June However, the focus will be on the tone of the policy statement and guidance that the Fed provides. We expect the Fed to upgrade its near-term outlook on the economy given the robust performance in Q and continued evidence of strong growth driven by the fiscal stimulus measures and strong consumption growth. Inflationary pressures appear to be accelerating but we expect the Fed to maintain its current assessment and continue to emphasize their symmetric inflation goal. An important take-away from the minutes of the FOMC meeting in June-2018 is that a number of Fed policymakers said it might soon be appropriate to change part of policy statement that refers to policy being accommodative. Many policymakers said gradual hikes could take fed funds rate above neutral level sometime next year. These statements accompanied by developments in the real economy make us believe that the Fed will likely reaffirm the need to maintain its tightening stance. Trade-war fears accompanied by some visible volatility in financial markets are unlikely to have a pronounced effect on Fed decision-making just yet, as the first-round effect of the fiscal stimulus in boosting private demand is likely to dominate in Recent comments from the President Trump regarding the Fed rate hikes are unlikely to impact decision making especially considering the strength of the economy. Please see important disclaimer at the end of this report Review of the main developments in the economy The growth of the US economy in the second quarter registered 4.1%, which is highest since Q32014 subsequently strengthening the case for two more rate hikes in this year. The main contributors to the upsurge were the strong growth seen in private consumption (4% versus 2.2% in the previous quarter) on the back of the income boost from the tax cuts and exports (13.3% versus 3.6% in the previous quarter) driven primarily by an expedited shipment from US produces prior to the imposition of the retaliatory tariffs from US trading partners coming into effect. In addition, core PCE in May touched the Fed s target 2% for the first time since April 2012 indicating that price pressures are building up. The rise in unemployment rate to 4% in June-2018 from 3.8% in the previous month is unlikely to persist and was driven by a mild uptick in the participation rate. Labour market conditions continue to remain tight visible in the initial jobless claims data and other surveys. Overall, the data releases since the FOMC meeting in June highlight that growth is picking and inflation is heading higher in response to positive output gaps.

2 Fed speak: A review Following are the key statements by the policy makers: FOMC members were optimistic on economic growth but expressed some concerns about the escalations in global trade-wars. Federal Reserve Chairman Jerome Powell signalled growing optimism on the U.S. economy while trying to reassure investors that the central bank would not derail the country s second-longest expansion by aggressively tightening monetary policy. Federal Reserve Chairman Jerome Powell gave an upbeat assessment of the U.S. economy but warned a sustained period of high tariffs on a wide variety of imports could be harmful to growth. He cautioned, however, that trade disputes could end up being a negative for the economy if they result in a protracted period of widespread higher tariffs. St. Louis Fed President James Bullard said he s hearing full-throated angst from regional companies, while Atlanta Fed President Raphael Bostic said businesses are extremely concerned about the prospects of a trade war. Market implications: More upside left in the USD The USD has continued to remain supported from visible evidence of outperformance of the US economy forcing the Fed to persist with its tightening bias. On the other hand, other major global central banks have maintained that their stances remain accommodative, particularly the European Central Bank and the Bank of Japan. We expect divergence in monetary policy cycles to remain the dominant theme that keeps the USD supported in the near-term. US yields have moved higher across the curve responding to robust dataflow and improvement in risk sentiment. We expect the uptrend to persist with the 10-year US treasury yield expected to trade in the 2.85%-3.05% over Q On the other hand, the US yield curve is expected to flatten further as rates at the shorter-end move higher responding to market s pricing in a high probability of two more rate hikes over Besides, the US Treasury is also set to announce its refunding program that will give some sense of the issuance quantum for the next quarter. Some response to that is likely especially if there is an increase in issuance at the shorter-end of the curve. Chart 1: Economy grew fastest since 2014 in Q2 Chart 2: Core PCE touched 2% first time since April 2012 Source: Bloomberg, ICICI Bank research Source: Bloomberg, ICICI Bank research Source: Bloomberg and ICICI Bank Research 2

3 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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