By VWArticles. Originally published at ValueWalk.
UPDATE 11:29AM EST on 6/15/2017 on the Federal Reserve System, rates and data
In her note below, Chief Economist at Stifel Fixed Income, Lindsey Piegza, Ph.D., offers insight on yesterday’s Fed Rate Hike, Global Central Bank Policy and the Russia Probe.
In part she says, “modest labor market gains and cooling inflation, appears to be the missing component that would normally be at the forefront of an accelerated rate path.”
See below for Piegza on the Federal Reserve System
Fed Hikes Rates Despite “Soft” Inflation; Global Central Bank Policy; Russian Probe Extended
Yesterday, the Fed opted to raise rates for the third time in six months, increasing the Federal funds rate from 1.00% to 1.25%.
Bottom Line: On the heels of additional “soft” inflation data released this week, the Fed’s decision to move forward with a second-round increase this year appears to be motivated by both a push from the market with yesterday’s rate hike fully priced in, according to Bloomberg, as well as a desire to rebuild the monetary policy tool kit. Justification from the data, on the other hand, as the economy shows lingering signs of weakness carrying over from the first-quarter amid still-sluggish consumer activity, modest labor market gains and cooling inflation, appears to be the missing component that would normally be at the forefront of an accelerated rate path. In other words, the Fed’s decision to raise rates on Wednesday, while expected, appears to be little motivated by the data but rather unfounded optimism, leaving the future pathway for rates even more uncertain at this point.
Other central bank policy adjustments this week: despite further action from the Fed, the People’s Bank of China left interest rates unchanged at the June 15th meeting. The rate for the 7-day reverse repo remained at 2.45%, the 14-day reverse repo at 2.60% and the 28-day reverse repo at 2.75%. Previously in March, mirroring the Fed’s decision to hike rates, the PBOC opted to raise rates on the 7-day, 14-day and 28-day repos.
The Swiss National Bank also held rates unchanged at today’s meeting citing a “multitude of political uncertainties.” The SNB opted to maintain negative rates, keeping its deposit rate at -0.75% as it has since January 2015.
In her note below, Chief Economist at Stifel Fixed Income, Lindsey Piegza, Ph.D., offers insight on today’s from the Federal Reserve System decision to raise rates despite support from data and to rebuild the monetary policy tool.
In part she says, “the Fed’s decision to move forward with a second-round increase this year appears to be motivated by both a push from the market with today’s rate hike fully priced in … [and] a desire to rebuild the monetary policy tool kit.”
As expected, the Fed opted to raise rates 25bps, from 1.00% to 1.25%. This is the second increase in 2017 and the third in the past seven months.
Bottom Line on the Federal Reserve System: On the heels of additional “soft” inflation data released this week, the Fed’s decision to move forward with a second-round increase this year appears to be motivated by both a push from the market with today’s rate hike fully priced in, according to Bloomberg, as well as a desire to rebuild the monetary policy tool kit. Justification from the data, on the other hand, as the economy shows lingering signs of weakness carrying over from the first-quarter amid still-sluggish consumer activity, modest labor market gains and cooling inflation, appears to be the missing component that would normally be at the forefront of an accelerated rate path. In other words, the Fed’s decision to raise rates today, while expected, appears to be little motivated by the data, leaving the future pathway for rates even more uncertain at this point. Acknowledgement of the recent decline in prices within the statement as well as with a modest downward revision to the forecast, however, appears to be taking a backseat to the Fed’s general optimism for improvement in growth and inflation. Without sizable and clear additional weakness, the Fed appears steadfast in their commitment to one additional rate hike this year. Once again, the Fed’s credibility is on the line as the data argues for quite an opposite position.
Federal Reserve System – more commentary from analysts.
Below are comments from Jeremy Lawson, Chief Economist at global asset manager Standard Life Investments (SLI), regarding the Federal Reserve System today.
SLI manages $350 billion and is merging with Aberdeen Asset Management. The new entity, once complete, will be one of the largest active managers in the world.
“On balance I see this as a modestly hawkish surprise relative to market expectations heading into the meeting.
Despite the 3mth annualised growth rate of core CPI inflation dropping to zero after today’s data, the Committee’s only substantive reaction was to downgrade its end year core PCE inflation forecasts by 0.2ppts.
Otherwise, the median 2018 and 2019 core inflation forecasts were unchanged, the median policy projections for 2017 and 2018 were unchanged (1 more rate hike this year, 3 next year) and the FOMC is still signalling that balance sheet normalisation will begin before year end. Yellen’ press conference was also fairly dismissive of the view that the recent inflation disappointments contained much of a signal.
Federal Reserve System – Philips curve believers?
This is therefore still a Committee that has faith that the Phillips Curve will reassert itself in the medium term. While the Committee is right to be doubtful that the extent of the recent weakness in core inflation prints will be sustained, their confidence in the timing and speed of the pick-up will be tested over the coming months.
With regard to the balance sheet, the FOMC was quite explicit about its intended path, issuing an additional communication document to set out their new exit principles. They will begin with a cap on Treasury security runoff of 6bn a month and a cap of 4bn a month on MBS runoff. That will increase in 6bn and 4bn increments respectively every 3 months until maxing out at 30bn and 20bn after 12 months. That implies that by end 2018 the balance sheet will be dropping by 50bn per month in those months where maturation is running at that pace, or an annualised rate of 600bn.
That implies that the Fed will get down to its target balance sheet size faster than I anticipated, unless a recession occurs in the meantime. The FOMC also made it clear that the federal funds rate will be the main policy instrument during normalisation, though a substantial negative shock that forced it to cut the federal funds rate would cause it to recommence reinvesting maturing securities.
The open question coming out of the meeting is whether the Fed’s guidance is credible. The initial market reaction suggests that markets are doubtful (modest further yield curve flattening; Fed dots not priced in; though the inflation data caused the bigger fixed income reaction on the day) and I have some sympathy for that reaction. As we wrote in the WEB this week, central banks (including the Fed) have systematically overestimated inflation pressures in recent years and I think there are downside risks to the Fed’s end-2018 inflation forecasts, though I do expect core inflation to
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