US Federal Reserve still on course to hike rates in 2015

The June meeting of the US Federal Reserve’s Monetary Policy Committee, held last week, concluded with no changes being made, which was in line with the market consensus, writes Oliver Mangan, chief economist at AIB.

The decision to leave policy unchanged was unanimous, for a fourth consecutive meeting.

In her post-meeting press conference, Federal Reserve chair Janet Yellen stated that the Fed “judged that economic conditions do not yet warrant an increase” in interest rates.

The committee would “like to see more decisive evidence that a moderate pace of economic growth will be sustained” before deciding it appropriate to hike rates.

As expected, the meeting statement showed some upgrading in the description of the economy’s recent performance.

The Fed noted that activity “has been expanding moderately” after its soft patch in the opening quarter of the year. It also commented that the “pace of job gains picked up.”

The updated Fed macro-economic forecasts contained only minimal changes.

GDP growth for 2015 was revised down to take into account the weak start to the year, while the unemployment rate was revised up slightly.

Overall, the committee’s view on the economic outlook has generally not altered since its last meeting in April. It continues to “see the risks to the outlook for economic activity and the labour market as nearly balanced.”

In terms of the committee members’ projections on the likely path of official interest rates, the median projection for end 2015 remains at 0.625%, which compares to a rate of 0.125% at present.

Both the end 2016 and end 2017 rate forecasts were lowered by 25bps to 1.625% and 2.875% respectively, emphasising that the Fed expects the pace of policy tightening to be gradual.

However, while the 2015 median projection was not altered, and is consistent with two rate hikes this year, there were some shifts in terms of individual views.

There are now five committee members indicating that only one rate increase is likely to be appropriate this year, compared to only one member previously. Nonetheless, 10 other members still see two rate hikes later this year.

The Fed is indicating a more aggressive path of rate hikes than the market is currently expecting.

Market pricing, at the moment, suggests only one full 25bps increase later this year. The market is also looking for the Fed funds rate to rise to 1.25% by end 2016, below the Fed’s projection of 1.625%.

Overall, the June meeting provided no clear signal as to the exact timing of when the Fed may start to increase interest rates.

Indeed, there would not appear to be a clear consensus within the Fed committee itself on when to start increasing rates.

Instead, the Fed has made sure it has not tied itself to a specific start date, retaining flexibility in deciding on the appropriate timeframe.

It continues to emphasise that future policy decisions remain very dependent on incoming data.

Nonetheless, 15 of the 17 Fed monetary policy committee expect rates to rise later this year.

Recent US data have been quite encouraging, pointing to a pick-up in the pace of economic activity.

If the incoming data, in particular employment, wage growth and inflation indicators, continue to register improvements, the Fed may have enough evidence by its September meeting to be comfortable enough to start increasing interest rates.

This would represent a significant change in the direction of global monetary policy, which has been on an easing course for the past eight years.

Indeed, more than half of the world economy has experienced further monetary policy easing, to date, in 2015.

It will be interesting to see how financial markets cope with such a change.

The Fed clearly hopes that its reassuring message – that the pace of rate increases will be gentle –means that the policy shift will not cause much dislocation in markets or economies