Policy Watch: US Fed Treasury Research Group For private circulation only US: Fed reinforces its dovish stance In line with our expectations, US Fed maintained status quo and kept the Fed funds target range unchanged at 0.25%-0.50%. Chart 1: Pace of normalisation to be gradual (%) 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 FOMC median Fed Funds rate projection December 2016 2017 2018 Long term Source: US Federal Reserve March Chart 2: Fed lowers median Fed funds rate projection Median Fed macro-economic projections 2016 2017 2018 Long term GDP (%YoY) Dec 2015 2.4 2.2 2.0 2.0 Mar 2016 2.2 2.1 2.0 2.0 Unemployment Rate (%) Dec 2015 4.7 4.7 4.7 4.9 Mar 2016 4.7 4.6 4.5 4.8 PCE inflation (%YoY) Dec 2015 1.6 1.9 2.0 2.0 Mar 2016 1.2 1.9 2.0 2.0 Core PCE inflation (%YoY) Dec 2015 1.6 1.9 2.0 n.a. Mar 2016 1.6 1.8 2.0 n.a. Median Fed funds rate (%) Dec 2015 1.375 2.375 3.250 3.500 Mar 2016 0.875 1.875 3.000 3.250 Source: US Federal Reserve March 16, 2016 Samir Tripathi samir.tripathi@icicibank.com Niharika Tripathi niharika.tripathi@icicibank.com Please see important disclaimer at the end of this report Across the board lowering in the median Fed funds rate was seen; in tandem with the Fed s stance of gradual policy normalisation. Considering the developments in the global and financial markets space, our assessment currently attaches a higher probability to a policy move in H2 2016. Fed maintains status quo The Fed maintained status quo in its policy meeting, broadly in line with expectation. It reaffirmed its view that the current 0.25%-0.50% target range for the Federal funds rate remains appropriate. The distribution of dots on the dotplot show that members have turned slightly dovish since the December policy meet. The distribution of dots for the 2017 and 2018 projections are also now clustered around a lower fed funds rate. Pace of normalisation to be gradual; 2 rate hikes factored in this year Across the board lowering in the median Fed funds rate was seen. This is in tandem with the Fed s stance of gradual policy normalisation. The median Fed funds rate projection for 2016 was lowered to 0.875% as compared to 1.375% in the December projection. The projections for 2017 and 2018 projections have been revised lower to 1.875% (prior 2.375%) and 3.0% (prior 3.25%) respectively. Further, the projection for the terminal rate was reduced to 3.25% from 3.50%. Fed upgrades assessment of economic activity The policy statement upgraded its assessment of the economic activity, citing that economic activity has been expanding at a moderate pace despite the global economic and financial developments of recent months vs. the growth slowed down quoted last meeting. However, in the Summary of Economic Projections (SEP) that accompanied the statement, the FOMC revised slightly lower its projection for GDP growth for 2016 and 2017. Further, the Fed accredited moderate increases in household spending (same as in the previous statement). The Committee continued to see improvement in the housing sector. Meanwhile, the Fed also acknowledged softness in business fixed investment and exports growth. Labour market recovery continues On the labour market conditions, Fed acknowledged that a range of indicators point to additional strengthening of labour the labour market. This is largely in line with firm gains in non-farm payrolls data in the intermeeting period. While the Committee kept its unemployment rate projections unchanged for 2016, it was lowered for all subsequent years. Inflation continues to run below the Fed target The Fed noted that inflation has continued to run below the Committee s longerrun objective, partly reflecting earlier declines in energy prices and decreasing prices of non-energy imports. However, it retained its view that inflation is expected to rise towards the 2% target in the medium-term as labour market improves further and transitory effects of lower energy prices wear off. The economic projections detailed minimal changes to the inflation forecasts. Fed continues to flag global risks While providing a relatively upbeat outlook for the US economy, the Fed highlighted risks from global economic and financial developments. This is in contrast to the January meet, wherein no risks were highlighted from global markets, the Fed had stated they will continue to monitor developments in the same.
Market Reaction: Broadly dovish The price action in the financial market suggests that the market reaction to the Fed policy announcement was broadly dovish. U.S. stocks and Treasuries rallied, while the Dollar tumbled after the policy announcement. Dollar index moved from 96.8 levels (prior to announcement) to 95.8 levels while the common currency rallied from 1.1083 to 1.1209 levels. In the fixed income market, 2 Yr and 10 Yr yield fell to 0.86% and 1.92% respectively from the pre-announcement levels of 0.98% and 1.99% respectively. The risk on was further reflected in sharp rally in gold prices which moved from USD 1230/oz to USD 1260/oz. as well as currencies such as Canadian Dollar and Brazilian Real. (12:51 IST) Incoming data and global developments to remain key going ahead In the post policy press conference, Fed Chair Janet Yellen acknowledged the evolving nature of participants assessment and the economic projections. This coupled with the risks highlighted from global developments in the policy statement leaves the Federal Reserve with sufficient room for maneuverability. While we believe in the relatively improved assessment of the US economy (with continued strengthening of labour market conditions), incoming data and developments in the global and financial markets will remain critical for determining the next policy action. Our assessment currently attaches a higher probability to a policy move in H2 2016. 2
Annexure A. FOMC statement comparison Growth FOMC statement comparison January 27th 2016 March 16th 2016 Our assessment Economic growth slowed late last year Economic activity has been expanding at a moderate pace despite the global economic and financial developments of recent months. Slightly Hawkish Labour market A range of recent labor market indicators, including strong job gains, points to some additional decline in underutilization of labor resources. A range of recent indicators,including strong job gains, points to additional strengthening of the labor market Neutral Other sectors Household spending and business fixed investment have been increasing at moderate rates in recent months, and the housing sector has improved further; however, net exports have been soft and inventory investment slowed. Household spending has been increasing at a moderate rate, and the housing sector has improved further; however, business fixed investment and net exports have been soft Slightly Dovish Inflation Inflation has continued to run below the Committee's 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Marketbased measures of inflation compensation declined further; surveybased measures of longer-term inflation expectations are little changed, on balance, in recent months. Inflation picked up in recent months; however, it continued to run below the Committee s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months. Neutral Risk to the outlook Inflation is expected to remain low in the near term, in part because of the further declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further. The Committee continues to monitor inflation developments closely.the Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook. Global economic and financial developments continue to pose risks. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further. The Committee continues to monitor inflation developments closely. Dovish Voting against the proposal None One (Esther L. George) *Highlighted portions represent additions to the statement 3
Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 May-18 Jul-18 Sep-18 Nov-18 Jan-19 B. Comparison of dot-plots on Fed funds rate projections December Dot-plot March Dot-plot Note: In the panel above, each shaded circle indicates the value (rounded to the nearest 1/8 percentage point) of an individual participant s judgment of the midpoint of the appropriate target range for the federal funds rate or the appropriate target level for the federal funds rate at the end of the specified calendar year or over the longer run. C. Comparison of market implied policy rate (%) 1.60 Fed fund futures implied policy rate Mar-16 Jan-16 1.20 0.80 0.40 0.00 Source: Bloomberg, ICICI Bank Research 4
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