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Markets over the past few years had reacted positively when US Federal Reserve did not raise interest rates. But this time around when Fed chairwoman Janet Yellen decided to hold interest rate market response was subdued. While the overall volatile scenario on account of Brexit contributed to the muted response, details in the statement and contents of the statement also set the undertone for the markets.
Here are the five key takeaways from the Fed meet that did not meet market expectations:
Possibility of a July rate hike: Yellen has not ruled out a rate hike in July. Speaking at post-meeting news conference, Yellen refused to rule out the option of hiking a key short-term interest rate at the Fed's next meeting. Yellen indicated that a string of decent reports in the next several weeks could prompt a rate hike. "It's not impossible by July" to see data that could point to raising rates, she said. Paul Ashworth of Capital Economics feels that a July rate hike is still possible, but it would require a meaningful rebound in payroll employment growth in June and a decisive UK vote to remain in the European Union. However, Michael Gapen of Barclays said that the hurdle for a July hike has moved higher and the statement confirms our belief that the committee will feel most comfortable once it has seem months of solid labour market data.
Subdued growth forecast: Using for the first time the phrase ‘new normal’ Yellen indicated that factors affecting growth and low interest rates are here to stay for some more time. Slow productivity growth or an aging population are issues that are pulling back economy growth limiting the potential of the economy to expand. There's a "sense that maybe that more of what is causing this rate to be low are factors that won't be rapidly disappearing but are part of the 'new normal,'" Yellen said at her news conference. Federal Reserve officials are less optimistic about the economy's growth this year and next, compared with three months ago, according to quarterly economic forecasts issued at the end of their two-day meeting. Fed policymakers now expect growth will be just 2 per cent this year and next, down from previous projections of 2.2 per cent this year and 2.1 per cent in 2017. For 2018 they have maintained the growth rate at 2 per cent.
Inflation forecast: Fed's preferred measure of inflation will be 1.4 per cent this year, slightly higher than the March forecast of 1.2 per cent. Their 2017 and 2018 forecasts are 1.9 per cent and 2 per cent, respectively. The Fed is still monitoring inflation and global economic developments, but it offered little insight into the changing impact of either factor. Brian Coulton of Fitch Ratings said that with Fed’s near term inflation forecast pushed up a little there is a possibility of Fed hiking rates in September and December 2016.
Brexit fear: Yellen said that the vote in the United Kingdom on whether to leave the European Union contributed to the Federal Reserve's decision to leave interest rates unchanged. "It was one of the factors in today's decision," Yellen said adding that the vote's outcome would impact future decisions. A vote by Great Britain to leave the EU could cause sharp swings in global markets and currency exchange rates.
Unemployment fears: Unemployment rate forecasts were little changed. Fed sees the rate at 4.7 per cent at the end of this year, the same as it is now. It will tick down to 4.6 per cent next year, the Fed projects, and remain at that level in 2018. Monthly job gains weakened in April and May, while measures of income growth fell. Weak employment growth in April and May 2016 meant that the economy was not stable enough to absorb further rate hikes.
Though the undertone of the Fed meet was dovish market has got a feeling that there is a higher slowdown to the economy. Number of participants in the Fed meet who expect only one hike has increased indicating that Fed needs more evidence before the next move says an economist at BNP Paribas. The suite of Fed communication gives us further support to our forecast of no rate hike this year adds the BNP Economist.
