The Federal Open Market Committee (FOMC) was unanimous in its decision to keep the federal funds rate at its current range of 0.25% to 0.50%, and released relatively dovish economic projections. Forecasts for the policy rate in 2017, 2018 and in the longer run all declined; in addition, six FOMC participants now expect just one interest rate increase in 2016, vs. only one participant in March.
The decision to maintain rates was expected by the market: before the release of the FOMC statement, the futures market was pricing a 0% probability of a rise. This probability has come down sharply, from 34% about a month ago-a time when first-quarter GDP growth was being revised higher, payroll growth was solid, and rhetoric from the Fed appeared to take a more hawkish tone. The key risks that have arisen since then are slowing momentum in the labour market, underlined by the weak May employment report, and increased Brexit risk, which has pushed global government bond yields to new lows.
The FOMC statement and Janet Yellen’s press conference suggest the Fed’s analysis of recent data is mixed. On one hand, the statement acknowledged the weak May employment report, highlighting that job gains had slowed. On the other, it pointed to consumer spending as an area of strength. The Fed also saw exports as being less of a drag, reflecting a weaker U.S. dollar, but noted that business investment remains soft and inflation continues to sit below the 2% target.
Still, the Fed’s projections show that policymakers continue to expect moderate economic expansion, low unemployment and 2.0% inflation in the longer run. By the end of the year, we believe that the unemployment rate could fall further and the inflation rate could rise more than the Fed’s projections of 4.7% and 1.5%, respectively. In our view, the strength of the U.S. economy and labour market, along with our expectations for inflation, has long supported more aggressive monetary tightening. It appears that the FOMC is increasingly factoring “vulnerabilities in the global market” in its domestic monetary policy decisions.
On balance, the Fed’s communications this week reduced the likelihood of a rate increase at the July meeting, but a September rate increase will be all but necessary for the FOMC to reach its projection of two rate increases this year. Although this very dovish Fed has contributed to a further decline in long-term interest rates, the low current level of yields reduces prospective bond returns from here. Moreover, while the Fed’s current policy stance is probably inappropriate for the long-term health of the US economy, equities could still move higher later this year as the economy strengthens and earnings rebound.
Source: Federal Reserve, J.P. Morgan Asset Management. Data as of 15 June 2016.*Forecasts of 17 Federal Open Market Committee (FOMC) participants, midpoints of central tendency except for Federal funds rate, which is a median estimate.