OLIVER MANGAN: Federal Reserve hints that rate hike may not be too far away

Federal Reserve Chairwoman Janet Yellen

As had been expected, last week’s US Federal Reserve meeting concluded with no changes to monetary policy, with the key fed funds interest rate remaining at 0.375%.

However, the decision to leave policy on hold was not unanimous, with three of the 10 voting council members favouring an immediate 25 basis points rate hike. 

This compares to the 9-to-1 split at the previous meeting in late July.

The tone of the post-meeting statement was also more upbeat than in July. 

The Fed noted that the US labour market had continued to strengthen and that growth had picked up from the modest pace seen in the first half of the year.

The US unemployment rate has dropped below 5%, while job growth averaged 230,000 over the summer months. It is not surprising, then, that some Fed officials want to hike rates immediately.

Another important change to the statement was the assessment that “risks to the economic outlook appear roughly balanced”.

This is the first time that such terminology has been used since just before the Fed hiked rates in December last year. It suggests that another rate hike may not be too far away.

In terms of the view on the economic outlook, the Fed revised down its GDP forecast for this year to 1.8%, from 2%, to take account of weaker-than-expected growth in the opening half of 2016. GDP growth forecasts for 2017 and 2018 were left at 2%.

The outlook for inflation and unemployment were also broadly unchanged. 

In the post-meeting press conference, Fed chairman Janet Yellen stated that the Fed judged that the case for a rate increase had strengthened, but decided for the time being to wait for further evidence of continued progress by the economy. 

Overall, the tone of the various Fed commentaries pointed to a willingness to tighten policy, sooner rather than later.

This view is supported by the Fed’s latest set of interest rate projections published after the meeting. 

They show that 14 of the 17 Fed council members expect to see policy tightening before the end of the year, with the median view being for one 25bps hike in the fed funds rate to 0.625%. 

However, this does represent a more cautious view, compared to the previous projections made in June, which had penciled in two hikes before the end of 2016.

Furthermore, the projections for 2017 and 2018 also show a less aggressive pace of rate increases. 

They now indicate two 25bps rate hikes in 2017, compared to the expectation of three hikes back in June, while the Fed still expects three hikes in 2018.

The Fed projections now indicate that rates will reach 1.875% by the end of 2018, versus previous forecast that they would finish the period at 2.375%. 

While the Fed is now projecting a slower pace of tightening, markets continue to expect an even more gradual pace of rate increases.

Futures contracts indicate that markets are pricing in just two rate hikes by the end of 2018, bringing the fed funds rate to just 0.875%, which is 1% lower than the Fed is projecting.

In summary, the Fed’s September meeting provided a strong signal that there will be a rate hike in the US later this year.

This is most likely to happen in December given the date of the next Fed meeting is just before the US Presidential election in November.

Thereafter, rates are likely to rise only gradually.

Markets took considerable comfort from the Fed signals that rates are likely to rise only very gradually. Continuing low rates are seen as supporting the recovery in economic activity and underpinning both the stock and bond markets.

The S&P-500 index had its best two-day run last week in more than two months. Obviously, any pick-up in the pace of rate tightening could hit markets hard.

Meanwhile, the dollar remains stable. A rate hike towards the end of the year should help underpin the US currency as rates are lower in the other major economies where central banks retain an easing bias.

Indeed, rates are negative in the eurozone, Japan and Switzerland, so positive US rates make the dollar all the more attractive.

Oliver Mangan, chief economist, AIB


Lifestyle

It’s the personal stories from Bruce Springsteen that turn his new ‘Western Stars’ documentary into something special, the director tells Esther McCarthy.Bruce Springsteen's Western Stars documentary more than just a music film

Apart from the several variations in its spelling in Irish and English, Inishtubbrid, Co Clare is also recognised by three other names: Wall’s Island; O’Grady’s Island and Inishtubber which surely puts it up there as the island with most names — not counting say Inisvickillane, Co Kerry which has about 33 variations to that spelling.The Islands of Ireland: In search of tranquility

More and more communities and volunteers are taking on environmental tasks around the country. In Clonmel, Co Tipperary, for example, people have united to get rid of Himalayan balsam, an invasive plant, from the banks of the River Suir.‘Bashing’ invasive plants

Halloween has become a consumer fest in recent years but there are a number of ways to reduce costs and waste — and make itHappy sustainable Halloween: Don’t be horrified with the waste at Halloween

More From The Irish Examiner