In Focus: US Fed Treasury Research Group For private circulation only FOMC Review: The doves are back in town? Chart 1: FOMC s Economic Projections The Fed hiked the target range for the federal funds rate by 25 bps on expected lines. The dot plot was lowered for 2019 to show only a cumulative 50 bps hike against previous expectations of 75 bps hike with another 25 bps rate hike expected in 2020. However, the underlying message provided by the Federal Reserve was dovish with an increase in emphasis that future actions are expected to remain data dependent. US yields softened particularly at the longer-end as investors got confirmation of a shallower rate hiking cycle that resulted in a further flattening of the US sovereign yield curve. We see this trend persisting in the near-term. The Fed expressing concerns about the health of the global economy resulted in risk aversion that in turn kept the USD bid. Fed meets market expectations Source: Fed, ICICI Bank Research Shivom Chakravarti shivom.chakravarti@icicibank.com Tel no: +91-22-4008-6273 Ashray Ohri ashray.ohri@icicibank.com Tel no: +91-22-4008-7249 December 20 th, 2018 Please see important disclaimer at the end of this report The FOMC delivered a 25 bps rate hike in its target range for the federal funds rate to the 2.25%-2.50% mark that was on expected lines. The dot plots were lowered across the years with the Fed projecting 2 more hikes for 2019 as opposed to three hikes earlier followed by one rate hike in 2020 and status quo in 2021. The median long-run rate was also lowered by 25 bps to 2.75% against 3% in the previous occasion that the forecasts were released in Septemebr-2018. To justify these revisions, the Fed lowered its growth and inflation projections (see chart 1) for 2018 and 2019 respectively while unemployment rate projections were increased for 2020 and 2021 respectively. Some important take-aways are: (a) The only major change in the policy statement was the references that were made to risks to the economic outlook. While the risks were continued to described as being balanced, there was a new line inserted alongside these risks to state that the committee will continue to monitor global economic and financial developments and assess their implications for the economic outlook. In short, the Fed is more concerned about the effect that slowing global growth momentum and tightening financial conditions will have on the outlook rather than being overly concerned about local US developments. (b) In the press conference, the Fed Chair laid great emphasis on future actions being more data dependent than was the case previously. He stated that there was a high degree of uncertainty about the path of rates. These statements presumable have to do with the lack of an acceleration in US inflation pressures. (c) The Fed chair offered little clarity on the neutral rate and accorded a high degree of uncertainty around it. (d) The Federal Reserve also emphasized that it expects to continue with the pace of its balance sheet tapering of USD 50 bn per month and that a further acceleration or an explicit medium-term target for the balance sheet was not on the cards. (e) The combination of changes made on the economic projections were viewed by the market to be on the dovish side.
Monetary policy expectations: Even as US growth prospects still remain fairly robust in the near-term, we believe that the FOMC s decision to turn dovish has to do with the fact that inflation is not accelerating and that the risks to the outlook have increased from exogenous developments and tightening financial conditions. The Fed Chair explicitly indicating that with the current rate hike the the FOMC has reached the bottom end of range of the committees estimates for the neutral rate implies that the rate hiking cycle will be shallower than previously assumed. However, given that labour markets are still robust and GDP growth is forecasted to be above trend level in 2019 at aggregate, we continue to expect 50 bps worth of rate hikes over 2019 with the Fed likely to end its rate hiking cycle. The Fed could deliver a series of two dovish rate hikes in 2019 especially if inflation continues to undershoot the Fed s expectations. Market implications: Although the Federal Reserve delivered a dovish rate hike as was being priced in by the markets, the tone particularly in the press conference stoked concerns about medium-term growth prospects both in the US economy and in the global economy. The explicit references on concerns about global growth prospects and financial market conditions was followed by the Federal Reserve Chairman emphasizing a more data dependent tone going forward. With US inflation pressures not showing signs of accelerating he gave an impression that there is a higher bar to hiking rates going forward in 2019 than was the case in 2018. Hence, the net result has been markets pricing in a shallower rate hiking trajectory that resulted in a further flattening in the UST 10 yr and UST 2 yr spread from 17 bps in yesterday s trading session 13 bps at the time of writing. We expect this flattening to inversion bias across different tenors in the sovereign yield and swap yield markets to continue in the near-term as the US fixed income markets grapple with a lower Fed terminal rate than was the case just a month back. As long as inflation does not accelerate sharply, we expect this trend to sustain. We see a further downside potential in the UST 10 yr and lower our projections to a near-term trading range of 2.70%-2.80%. The story in the FX markets was a bit different. First, the Fed emphasized that the main source of risk to the US growth outlook could come from global developments. This in turn resulted in a hefty bout of risk aversion pulling US and global equity markets lower. Inadvertently the Fed s concerns about the global economy triggered safe-haven buying that pushed the DXY higher in the process. While we would not rule out further possible upside, we reiterate our bearish USD call over the medium-term given that we expect the growth divergence between the US and non-us world to shrink. Chart 2: Federal Reserve dot plot from December 2018 policy Source: Federal Reserve, ICICI Bank Research 2
FOMC statement comparison November 8th, 2018 December 20th, 2018 Our assessment Growth The labor market has continued to strengthen and that economic activity has been rising at a strong rate. The labor market has continued to strengthen and that economic activity has been rising at a strong rate. 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 remained low Other sectors Household spending has continued to grow strongly while business fixed investment has moderated from its rapid pace earlier in the year Household spending has continued to grow strongly while business fixed investment has moderated from its rapid pace earlier in the year Inflation 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. 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 in the target range for the federal funds The Committee expects that further gradual rate will be consistent with sustained expansion of increases in the target range for the federal funds economic activity, strong labor market conditions, rate will be consistent with sustained expansion of and inflation near the Committee s symmetric 2 economic activity, strong labor market conditions, percent objective over the medium term. Risks to the and inflation near the Committee s symmetric 2 economic outlook appear roughly balanced, but percent objective over the medium term. Risks to the will continue to monitor global economic and economic outlook appear roughly balanced. financial developments and assess their implications for the economic outlook dovish On Fed funds rate 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 2 to 2-1/4 percent. 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 2-1/4 to 2-1/2 percent. Voting 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; Richard H. Clarida; Mary C. Daly; Loretta J. Mester; and Randal K. Quarles. Voting for the FOMC monetary policy action were: Jerome H. Powell, Chairman; John C. Williams, Vice Chairman; Thomas I. Barkin; Raphael W. Bostic; Michelle W. Bowman; Lael Brainard; Richard H. Clarida; Mary C. Daly; Loretta J. Mester; and Randal K. Quarles. 3
ICICI Bank: ICICI Bank Towers, Bandra Kurla Complex, Mumbai- 400 051. Phone: (+91-22) 2653-1414 Treasury Research Group Economics Research Kamalika Das Economist (+91-22) 4008-1414 (ext 6280) kamalika.das@icicibank.com Shivom Economist (+91-22) 4008-1414 (ext 6273) shivom.chakravarti@icicibank.com Chakravarti Anushri Bansal Economist (+91-22) 4008-1414 (ext 6220) anushri.bansal@icicibank.com Sumedha Economist (+91-22) 2653-1414 (ext. 7243) sumedha.dasgupta@icicibank.com Dasgupta Ashray Ohri Economist (+91-22) 2653-1414 (ext. 7249) ashray.ohri@icicibank.com Pradeep Kumar Economist (+91-22) 2653-1414 (ext. 6272) pradeep.kmr@icicibank.com Yash Panjrath Economist (+91-22) 2653-1414 (ext. 8161) yash.panjrath@icicibank.com Sparsh Chhabra Economist (+91-22) 2653-1414 (ext. 7309) sparsh.chhabra@icicibank.com Treasury Desks Treasury Sales (+91-22) 6188-5000 Currency Desk (+91-22) 2652-3228-33 Gsec Desk (+91-22) 2653-1001-05 FX Derivatives (+91-22) 2653-8941/43 Interest Rate Derivatives (+91-22) 2653-1011-15 Commodities Desk (+91-22) 2653-1037-42 Corporate Bonds (+91-22) 2653-7242 4
Disclaimer Any information in this email should not be construed as an offer, invitation, solicitation, solution or advice of any kind to buy or sell any financial products or services offered by ICICI Bank, unless specifically stated so. ICICI Bank is not acting as your financial adviser or in a fiduciary capacity in respect of this proposed transaction with you unless otherwise expressly agreed by us in writing. Before entering into any transaction you should take steps to ensure that you understand the transaction and have made an independent assessment of the appropriateness of the transaction in the light of your own objectives and circumstances, including the possible risks and benefits of entering into such transaction. You may consider asking advice from your advisers in making this assessment Disclaimer for US/UK/Belgium/Canada residents This document is issued solely by ICICI Bank Limited ( ICICI ). The material in this document is derived from sources ICICI believes to be reliable but which have not been independently verified. In preparing this document, ICICI has relied upon and assumed, the accuracy and completeness of all information available from public sources ICICI makes no guarantee of the accuracy and completeness of factual or analytical data and is not responsible for errors of transmission or reception. The opinions contained in such material constitute the judgment of ICICI in relation to the matters which are the subject of such material as at the date of its publication, all of which are expressed without any responsibility on ICICI s part and are subject to change without notice. ICICI has no duty to update this document, the opinions, factual or analytical data contained herein. The information and opinions in such material are given by ICICI as part of its internal research activity and not as manager of or adviser in relation to any assets or investments and no consideration has been given to the particular needs of any recipient. DISCLAIMER FOR BAHRAIN RESIDENTS: ICICI Bank Limited's Bahrain Branch, located at Manama Centre, Manama, P.O. Box-1494, Bahrain, is licensed and regulated as a Conventional Retail Bank by the Central Bank of Bahrain (CBB). The CBB assumes no responsibility for the accuracy and completeness of the statements and information contained in this document and expressly disclaims any liability whatsoever for any loss arising from reliance upon the whole or any part of the contents of this document. Certain financial products mentioned herein may be available only to accredited investors. In such cases, following criteria should be met by accredited investors as defined under the CBB rule book: a) Individuals holding financial assets (either singly or jointly with their spouse) of USD 1,000,000 or more, excluding customer s principal place of residence; b) Companies, partnerships, trusts or other commercial undertakings, which have financial assets available for investment of not less than USD 1,000,000; or c) Governments, supranational organizations, central banks or other national monetary authorities, and state organizations whose main activity is to invest in financial instruments (such as state pension funds). In case of any doubt regarding the suitability of the products and any inherent risks involved for specific individual circumstances, please contact your own financial adviser. Investments in the financial product or financial services to which this document relates are not considered deposits and are therefore not covered by the Kingdom of Bahrain s regulation on Protecting Deposits and Unrestricted Investment Accounts. Except for the historical information contained herein, statements in this document, which contain words or phrases such as 'will', 'would', etc., and similar expressions or variations of such expressions may constitute 'forward-looking statements'. These forward-looking statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those suggested by the forward-looking statements. ICICI Bank undertakes no obligation to update forward-looking statements to reflect events or circumstances after the date thereof. Nothing contained in this publication shall constitute or be deemed to constitute an offer to sell/purchase or as an invitation or solicitation to do so for any securities or financial products of any entity. ICICI Bank and/or its Affiliates, ("ICICI Group") make no representation as to the accuracy, completeness or reliability of any information contained herein or otherwise provided and hereby disclaim any liability with regard to the same. ICICI Group or its officers, employees, personnel, directors may be associated in a commercial or personal capacity or may have a commercial interest including as proprietary traders in or with the securities and/or companies or issues or matters as contained in this publication and such commercial capacity or interest whether or not differing with or conflicting with this publication, shall not make or render ICICI Group liable in any manner whatsoever & ICICI Group or any of its officers, employees, personnel, directors shall not be liable for any loss, damage, liability whatsoever for any direct or indirect loss arising from the use or access of any information that may be displayed in this publication from time to time This document is intended for distribution solely to customers of ICICI. No part of this report may be copied or redistributed by any recipient for any purpose without ICICI s prior written consent. If the reader of this message is not the intended recipient and has received this transmission in error, please immediately notify ICICI, Kamalika Das, E-mail: kamalika.das@icicibank.comor by telephone at +91-22-2653-7233 and please delete this message from your system. 5
DISCLAIMER FOR DUBAI INTERNATIONAL FINANCIAL CENTRE ( DIFC ) CLIENTS: This marketing material is distributed by ICICI Bank Limited., Dubai International Financial Centre (DIFC) Branch, a category 1 Authorized Firm and regulated by the Dubai Financial Services Authority and located at Central Park Building, Office Tower 27-31, Level 27, DIFC, P.O. Box 506529, Dubai, U.A.E. This marketing material is intended to be issued, distributed and/or offered to a limited number of investors who qualify as Professional Clients pursuant to Rule 2.3.3 of the DFSA Conduct of Business Rulebook, or where applicable a Market Counterparty only, and should not be referred to or relied upon by Retail Clients and must not be relied upon by any person other than the original recipients and/or reproduced or used for any other purpose. Professional Clients as defined by DFSA need to have net assets of USD 1,000,000/- and have sufficient experience and understanding of relevant financial markets, products or transactions and any associated risks. The DFSA has no responsibility for reviewing or verifying any marketing material or other third party investment documents in connection with the marketing material / report. Accordingly, the DFSA has not approved the marketing material or third party investment documents nor taken any steps to verify the information set out in the same, and has no responsibility for it. The securities to which this document relates may be illiquid and/or subject to restrictions on their resale. Prospective purchasers of the securities offered should conduct their own due diligence on the securities. If you donot understand the contents of this document you should consult an authorised financial adviser. DISCLOSURE FOR RESIDENTS IN THE UNITED ARAB EMIRATES ( UAE ): This document is for personal use only and shall in no way be construed as a general offer for the sale of Products to the public in the UAE, or as an attempt to conduct business, as a financial institution or otherwise, in the UAE. Investors should note that any products mentioned in this document, any offering material related thereto and any interests therein have not been approved or licensed by the UAE Central Bank or by any other relevant licensing authority in the UAE, and they do not constitute a public offer of products in the UAE in accordance with the Commercial Companies Law, Federal Law No. 2 of 2015 (as amended) or otherwise. 6