Macro Snapshot:Next rate hike likely to be postponed to Jun at the earliest
FOMC statement shifts to dovish tone The Federal Reserve left its interest rateunchanged, in line with market expectations. In its statement, the assessment of the USeconomy was adjusted downwards slightly. The Fed said “household spending andbusiness fixed investment have been increasing at moderate rates in recent months”, achange from the “solid rate” mentioned at the last meeting. Officials also expressed theirconcerns about prices and said that “market-based measures of inflation compensationdeclined further”. The stock market crash also caught the Fed’s eye, leading it to say theywill be “closely monitoring global economic and financial developments”. Overall, thestatement showed a lack of confidence in the Fed’s outlook for the US economy. It hastherefore reiterated that rate hikes will be gradual, and that monetary policy will remainaccommodative to support the economy.
Officials have a track record of being overly optimistic Based on the economicprojections at the Dec 2015 meeting, officials expected four hikes in 2016 and four hikesin 2017, which is equal to raising rates once per quarter. Some officials therefore originallyplanned to hike rates at the Mar meeting. However, Fed officials are often overlyoptimistic. If we look back to the economic projections at the Dec 2014 meeting, officialsforecasted an end to the 2015 Fed Funds rate of 1.125%, equal to four hikes in 2015;however, there was only one. If we compare the four projections in 2015 (Mar, Jun, Sep,Dec), officials lowered their interest rate forecast each time (Fig 1). These adjustmentsshow that officials have been too ambitious about the pace of tightening. In our view,hawkish officials are likely to delay their hike plan, meaning the Fed is unlikely to raiserates at the Mar meeting.
Looking ahead, there are three concerns that could slow the pace of rate hikes:
First, an unexpected decline in oil prices According to the Dec FOMC minutes, thecommittee expects inflation to increase gradually, based on the expectation of stabilizingenergy prices and a strengthening labor market. However, oil prices dropped by almost20% in Jan. The unexpected downward pressure on oil prices is likely to delay or weakenthe rebound in inflation (Fig 2). We expect PCE inflation to remain around zero for thenext few months, and believe it is now less likely to climb to the Fed’s 2% target.
Second, the sharp fall in stock markets In its statement, the Fed emphasized that theyhave again closely followed financial markets. In the first three weeks of the year, financialmarket volatility increased substantially, and the S&P 500 dropped to its lowest level inalmost two years (Fig 3). Given the worsening environment in emerging markets, stockmarkets are likely to be volatile for the next few weeks. In addition, uncertaintiessurrounding the Fed’s policy may result in continued market volatility in the months ahead.
According to the Fed Funds Futures contract data, traders expect just one or two ratehikes this year, compared with the Fed’s previous guidance of four hikes. The differencein interest rate expectations between the market and the Fed may result in continuedmarket volatility in the coming months.
Third, the economic slowdown in emerging markets According to the latest WorldEconomic Outlook (WEO) report from the IMF, GDP growth in China may slow to 6.3% in2016, from 6.9% in 2015. Brazil and Russia, another two BRICS countries, are evenexpected to see growth drop by 3.5% and 1% respectively, continuing their economicrecessions (Fig 4). Global economic weakness is likely to have a negative impact on USexports, and put downward pressure on the US labor market in 2016.
Although the Fed has kept all options open, we do not expect it to hike rates at the Marmeeting, and believe a continuation of the global economic downturn would see ratedecisions becoming even more cautious. In our view, the earliest possible time for thenext rate hike will be the Jun meeting.
