The Fed is maintaining its key interest rates within the range of 0.25-0.50%. The announcement is part of a process of gradual interest rate hikes this year, which still translates into a median forecast of two rate hikes in 2016. GDP forecasts have been revised downwards by 0.2 points, while inflation forecasts have been revised upwards by 0.1 points for the core index.
GDP for 2016 has been revised down to 2.0% from 2.2% in the latest forecast in March 2016. Core inflation has been revised up from 1.6% to 1.7%, total inflation from 1.2% to 1.4%, while the unemployment rate is expected to remain unchanged at 4.7%.
Economic activity is expected to exceed 2% according to the new projections.Private consumption continues to make a positive and significant contribution to the US economy, with household income up 4.4% year-on-year spending up 4.1% in a context of inflation (PCE Core – Fed target) at 1.7% (Fed’s year-end target) and a Michigan consumer confidence index back up to 94. However, the Fed unfortunately characterized the rebound in consumer spending as temporary during its press conference. Another positive contributor to growth is real estate, with prices continuing to rise at a steady pace of 5%: building permits are up to 1,145,000 and new construction is close to 600,000 units. The new figures will be released on Friday, June 17. Investment is disappointing, particularly during the winter period.
The labor market continues to improve significantly, with an unemployment rate of 4.7%, average hourly wages up 2.5% year-on-year, and payrolls slowing but still up 1.7% year-on-year. This is despite a labor force participation rate that is still too low compared to the demographic trend (62.6%) and an unemployment rate among part-time workers that is too stable (which did not fall last month, unlike U-3 unemployment at 4.7%).
Investors saw zeroprobability of a rate hike in June (0%) and only a slight probability for the July (9%) and September (19%) meetings. Only the March 2017 meeting appears likely to see a rate hike, according to the probabilities derived from futures prices (49%).
The dot plots (hike forecasts by Fed members) remain low, with a median of two hikes for 2016, which remains unchanged, and near unanimity on two rate hikes in 2016 among 15 of the 17 members. The new development is that five FOMC members, who were very hawkish in March (at least three rate hikes this year), have become very cautious, revising their forecasts from three to four hikes to a maximum of two.
– FED Fund rate at 0.50-0.75: 6 members (35% of members) compared with 1 in March
– FED Fund rate at 0.75-1.00: 9 members (52% of members) compared to 9 in March
– FED Fund rate at 1.00-1.25: 1 member (5%) compared to 3 in March
– FED Fund rate at 1.25-1.50: 1 member (5%) compared to 4 in March
The Bremain/Brexit referendum on June 23 remains one of the factors behind the Fed’s passivity , although it could take action in July or even September. The risk associated with financial market developments has increased, for example through implied volatility in the foreign exchange market, particularly for sterling. Spreads on peripheral sovereign debt bonds are also tightening as the probability of Brexit increases (46% in polls, 40% among bettors), pushing the 10-year Bund into negative territory and the 10-year UK bond to 1.17%. These two examples reflect the instability of financial markets, which would be exacerbated in the event of an increase in interest rate differentials resulting from a hike by the Fed.
See the Fed’s projections and statement:
