Policy Watch: US Fed Treasury Research Group For private circulation only US: Fed stands pat; sees fewer rate hikes in the future 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 likely to be slightly more gradual (%) 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 FOMC median Fed Funds rate projection March June 2016 2017 2018 Long term Source: US Federal Reserve Chart 2: Fed keeps 2016 median Fed funds rate projection unchanged; lowers projection for the long term Median Fed macro-economic projections 2016 2017 2018 Long term GDP (%YoY) Mar 2016 2.2 2.1 2.0 2.0 Jun 2016 2.0 2.0 2.0 2.0 Unemployment Rate (%) Mar 2016 4.7 4.6 4.5 4.8 Jun 2016 4.7 4.6 4.6 4.8 PCE inflation (%YoY) Mar 2016 1.2 1.9 2.0 2.0 Jun 2016 1.4 1.9 2.0 2.0 Core PCE inflation (%YoY) Mar 2016 1.6 1.8 2.0 n.a. Jun 2016 1.7 1.9 2.0 n.a. Median Fed funds rate (%) Mar 2016 0.875 1.875 3.000 3.250 Jun 2016 0.875 1.625 2.375 3.000 Source: US Federal Reserve June 15, 2016 Kamalika Das kamalika.das@icicibank.com Radhika Wadhwa radhika.wadhwa@icicibank.com Please see important disclaimer at the end of this report The median Fed funds rate for this year retained the projection of two rate hikes. Projections for 2017 and 2018 were revised downward. GDP forecast also revised lower. Highlights importance of incoming data prints in determining the future trajectory of interest rates. Fed maintains status quo In line with our expectation, the Federal Reserve voted unanimously to maintain status quo in its policy meeting today, keeping the target range for the Fed funds rate unchanged at 0.25%-0.50%. The distribution of dots on the dot-plot shows that members continue to see two rate hikes this year. However, participants have turned slightly dovish since the March policy meet. The distribution of dots for the 2017 and 2018 projections are also now clustered around a lower fed funds rate. Median Fed funds rate unchanged for 2016; fewer hikes going ahead The median Fed funds rate was lowered across the board, with the exception of this year s projection. Policymakers continued to expect two rate hikes this year, with the median Fed funds rate projection for 2016 steady at 0.875%. Curiously, one member projected only one rate hike in 2016 and no subsequent action over the next two years. The median projections for 2017 and 2018 were revised lower to 1.625% (prior 1.875%) and 2.375% (prior 3.0%) respectively. Further, the median projection for the terminal rate was also reduced to 3.00% from 3.25%. Lowers projection for economic activity The policy statement lowered the GDP projection for 2016 and 2017 to its long term target level of 2%, despite stating that growth in economic activity appears to have picked up. The Fed added that while household spending and the housing sector have strengthened, business fixed investment has been soft. Remains optimistic on labour market recovery The Fed acknowledged the slowing pace of improvement in the labour market in the wake of the disappointing nonfarm payrolls data for May. However, the Committee continued to expect the gradual strengthening of labour market indicators going forward. Fed Chair Janet Yellen cautioned against reading too much into one data print. Unemployment rate projection for 2018 was revised upwards, though projections for all other years remained intact. 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 markets improve further and transitory effects of lower energy prices wear off. Headline and core inflation expectations for this year were revised upwards. Subdued market reaction The reaction of financial markets to the policy announcement has been muted as the decision was broadly on expected lines. US stock markets were marginally lower and the Dollar index was little changed after the policy announcement. 2Y and 10Y Treasury yields declined after the policy decision and are currently hovering around 0.68% and 1.58% respectively.
Gold prices rose to ~USD 1290/oz. The market implied probability for a July rate hike fell from 15.7% to 5.8% while odds of a December hike slipped to 40.9% vs. 51% yesterday. (1:30 IST) Incoming data to remain key going ahead The tone of Chair Janet Yellen s press conference introduced a fair degree of uncertainty into how the Fed perceives the US recovery. The Chair revealed that next week s British Referendum was one of the factors responsible for keeping interest rates unchanged. On the upcoming US Presidential elections, she added that politics will not be taken into account while discussing policy. The policy also made no mention of the balance of risks, though Yellen did indicate that foreign rates and prospects for global growth inadvertently factor into the Fed s decision making process. While the policy has kept the window open for a July rate hike, contingent on incoming data, it is interesting to note the change in dynamics within the Committee. Six members see only one rate hike as appropriate this year, in stark contrast to the one member in the March policy meeting. This calls into question the likelihood of a second rate hike this year. Going ahead, incoming data prints will continue to hold the key to gauging the future course of action by the Fed. 2
Annexure A. FOMC statement comparison Growth April 27th 2016 June 15th 2016 Our assessment Labor market conditions have improved further even as growth in economic activity appears to have slowed. Pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up Dovish Labour market A range of recent indicators, including strong job gains, points to additional strengthening of the labor market. Although the unemployment rate has declined, job gains have diminished. Dovish Other sectors Inflation Growth in household spending has moderated, although households real income has risen at a solid rate and consumer sentiment remains high. Since the beginning of the year, the housing sector has improved further but business fixed investment and net exports have been soft. Growth in household spending has strengthened. Since the beginning of the year, the housing sector has continued to improve and the drag from net exports appears to have lessened, but business fixed investment has been soft. Inflation has continued to run below the Inflation has continued to run below the Committee s 2 percent longer-run objective, Committee's 2 percent longer-run objective, partly partly reflecting earlier declines in energy reflecting earlier declines in energy prices and in prices and falling prices of non-energy prices of non-energy imports. Market-based imports. Market-based measures of inflation measures of inflation compensation declined; compensation remain low; survey-based most survey-based measures of longer-term measures of longer-term inflation expectations inflation expectations are little changed, on are little changed, on balance, in recent balance, in recent months. months. Slightly Hawkish Slightly dovish Risk to the outlook In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.the Committee continues to closely monitor inflation and labour market indicators and global economic and financial developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.the Committee continues to closely monitor inflation and labour market indicators and global economic and financial developments. -- Voting against the proposal Esther L. George No dissents 3
B. Comparison of dot-plots on Fed funds rate projections March Dot-plot June 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. 4
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