Following its March meeting last week, the FOMC dropped its commitment to being ‘patient’ about increasing the federal funds rate, opening up the possibility of an initial rate rise as early as June. However, the revised economic projections released by the Fed tell a different story.
While much of the attention on last week’s FOMC meeting was focused on whether the use of the word ‘patient’ would come out of its statement, the real story coming out of the meeting was the subdued outlook in growth and in the Fed’s updated internal economic projections, as well as Chair Janet Yellen’s comments on the impact of the stronger US dollar.
The table below shows the FOMC member projections of key economic variables coming out of the March meeting, versus the projections made in December last year.
Source: Federal Reserve
In December, the central tendency for FOMC members was to project that 2015 GDP growth would be between 2.6% to 3.0%. This has now been revised down to a range of 2.3% to 2.7%. While this is not in itself a major revision, it reflects a number of recent economic statistics coming in weaker than expected. Yellen also pointed to a subdued housing market and a stronger dollar as restraining factors on growth.
And, despite the improved outlook for unemployment, the FOMC’s revised inflation estimates were also telling. The headline inflation project was cut from a range of 1.0% to 1.6% down to 0.6% to 0.8% for 2015, well below the Fed’s objective of delivering long term inflation at 2% per annum.
Policymakers also cut their estimate for the federal funds rate at year end to 0.625%, down from a forecast of 1.125% in December. The outlook for 2016 fell to 1.875% from 2.5%.
Along with the revised projections, this meeting was most interesting for the fact that the Fed talked about currency, something which it hasn’t done very often in the recent past. Yellen, who also lowered her assessment of the economy, said the strong dollar has weighed on consumer prices and contributed to weak export growth and low import prices.
It is likely that the strengthening in the US dollar has prompted a rethink inside the Fed. The rise in the dollar means, effectively, that monetary policy has already been tightened to some extent. The US economy has traditionally been less vulnerable to currency movements, but as its traded goods sector grows the impact of the dollar is now becoming more pronounced.
And this, along with the recent weaker than expected data, has prompted FOMC members to become more pessimistic about the prospects for the US economy than they were in December. Along with the economic indicators, we expect the Fed will pay close attention to further strengthening in the US dollar and its impact on growth and inflation in its decision making on interest rates.
While ‘patience’ has come out of the Fed’s statement, the Fed’s revised projections would indicate that it won’t be in any rush to raise rates either. As we saw from the market’s reaction after last week’s meeting, a less hawkish stance from the Fed is likely to further the rally in US bond yields.
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