Tags: fed | economy | rate hike | fomc

Fed to Confront Skeptical Market View of Gradual Rate Hike Pace

Fed to Confront Skeptical Market View of Gradual Rate Hike Pace
(Dollar Photo Club)

Thursday, 21 April 2016 10:45 PM EDT

The Federal Reserve’s dilemma next week is how to skip an interest-rate hike for a third straight meeting without cementing expectations that policy is on hold for months to come.

“The Fed doesn’t want to leave the impression that they will never hike rates,” said Thomas Costerg, senior economist at Standard Chartered Bank in New York.

Chair Janet Yellen and her colleagues on the Federal Open Market Committee gather April 26-27, and investors see zero probability of a rate hike. No press conference is scheduled after the meeting, confining their communication to a short statement with which to describe how they see the economy and likely next steps.

The Fed is in this bind because U.S. growth has slowed in the opening months of the year, validating Yellen’s decision to delay FOMC action in January and March after the Fed hiked in December for the first time in nearly a decade, while raising doubts that the central bank will be able to proceed with gradual rate increases as it expects.

Officials have penciled in two rate hikes this year, according to forecasts they updated in March, but investors are more skeptical. Prices in federal funds futures contracts indicate investors see a higher probability of just one increase in 2016, though some Fed officials have warned this judgment is too pessimistic.

This divergence between the market and the Fed, which has been a frequent occurrence during the recovery, shows that investors view the Fed’s outlook as an optimistic baseline which places too little weight on downside risks to the economy that could prevent it from tightening.

The Fed’s interest rate forecast “is basically saying, if things work out, they are going to tighten two times,” said Vincent Reinhart, chief economist for Standish Mellon Asset Management LLC in Boston. In the current environment, ”it’s hard to be confident that things are going to work out.”

The FOMC, which lifted its target range for the benchmark policy rate to 0.25 percent to 0.5 percent in December, has had to steer policy through a variety of unexpected shocks.

The dollar’s rally against key currencies starting in mid-2014 slowed exports and dented overall growth. Tumbling energy costs have depressed market- and survey-based measures of inflation expectations, worrying some Fed officials that they may struggle to push inflation back up to their 2 percent goal. Slower Chinese growth and uncertainty over the strength of the world economy triggered market turmoil and financial conditions tightened in January and February, though they have eased somewhat since. 

Add to this questions about whether the first-quarter U.S. slowdown spills into the second quarter, causing the Fed -- yet again -- to mark down its forecasts for the economy and the pace of policy tightening.

There are also risks on the horizon. Britain holds a referendum on the country’s membership in the European Union on June 23, eight days after Fed officials meet. A vote to exit could roil financial markets, sink the pound, and have consequences for European growth generally.

Still, regional Fed chiefs Eric Rosengren of Boston and Charles Evans of Chicago told investors this month that the committee’s forecast for two more rate increases this year is a solid bet.

“The very shallow path of rate increases implied by financial futures market pricing would likely result in an overheating that necessitates the Fed eventually raising interest rates more quickly than is desirable,” Rosengren said in a speech on April 18. “We will be raising rates faster than what’s reflected in the financial markets,” he later told his audience.

June Meeting

Investors see about a 22 percent chance that the benchmark lending rate is pushed up another quarter point from its current range of 0.25 percent to 0.5 percent in June. Yellen gives a press conference after the June meeting, and the Fed also releases updated economic forecasts.

“The challenge really is deciding how much to telegraph about June being a probability,” said Guy Lebas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia.

Going in Fed officials’ favor is ongoing strength in the labor market, which Evans called “the most important fundamental factor supporting household spending,” and a rise in measures of inflation minus food and energy.

U.S. employers added an average 209,000 new jobs in the first three months of the year, while core inflation, using the Fed’s preferred personal consumption expenditures price index, rose 1.7 percent for the 12 months ending February. Rosengren said this was “much closer to the Federal Reserve’s 2 percent target than were the core PCE readings in 2015.”

Still, there is a high amount of uncertainty about the outlook, and the risks of having to cut rates back to nearly zero are still too high for Fed officials to signal anything about near-term hikes, said Laura Rosner, senior U.S. economist at BNP Paribas in New York.

A strong signal next week on a move at the June FOMC would be “a dangerous game because you have so little room” with the policy rate if there is a shock, Rosner said.

“There is an argument for risk management and waiting for extra growth to build before explicitly signaling a near-term hike,” she added.

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The Federal Reserve's dilemma next week is how to skip an interest-rate hike for a third straight meeting without cementing expectations that policy is on hold for months to come."The Fed doesn't want to leave the impression that they will never hike rates," said Thomas...
fed, economy, rate hike, fomc
Thursday, 21 April 2016 10:45 PM
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