Post-FOMC Meeting - March 2017

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US Dollar slides to one month low despite Federal Reserve rate hike

 

In line with the overwhelming market consensus, the Federal Reserve hiked interest rates in the US for only the third time in a decade at its monetary policy meeting on Wednesday evening.

The FOMC raised the Fed funds rate by 25 basis points to a range between 0.75-1.0%, having hiked rates for the first time in a year in December. It was, however, not a unanimous decision with one of the members, Minneapolis Fed President Kashkari, voting in favour of keeping rates unchanged.

With a March hike very well telegraphed by policymakers in the past few weeks, and indeed fully priced in by the market, investors paid far more attention to the Fed’s statement and updated economic projections. The statement itself was fairly optimistic, claiming that business investment had firmed and acknowledging that inflation was “moving towards the committee’s 2 percent longer-run objective”. According to the statement, further rate increases in the US would be “gradual”, and it will continue to “carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.”

A slight disappointment to the market was the Federal Reserve’s updated ‘dot plot’, which shows where each member of the committee expects interest rates to be at the end of each year. The committee’s dot chart was largely unchanged from December, showing a median rate expectation of between 1.25-1.5% by the end of this year and 2-2.25% by the end of 2018 (Figure 1).

 

Figure 1: FOMC March 2017 ‘Dot Plot’

Figure_1_FOMC_March_2017__Dot_Plot_.jpg

Source Federal Reserve Date: 15/03/2017

 

Nine members of the committee expect a total of three rate increases in 2017, suggesting the Fed is no more of a hurry to hikes rates than it was at the release of its previous dot plot in December. Absent surprises in the macroeconomic front, the Fed remains set to hike rates by 0.75% a year until an equilibrium level of about 3% is reached. We had been expecting an upward revision in recognition of recent stronger than-expected-inflation and labour reports.The Fed did revise up modestly its projection for rates in 2018, so our forecast wasn't a complete miss.

The slightly less hawkish tone of communications from the central bank came as somewhat of a surprise, particularly given the recent hawkish shift in rhetoric from Fed officials, including Chair Janet Yellen. Investors reacted by sending the US Dollar lower across the board. The Dollar slipped by over half a percent against the Euro to its weakest position in two weeks, while falling by a similar amount against Sterling (Figure 2).

 

Figure 2: EUR/USD & GBP/USD (15/03/2017 -16/03/2017)

Figure_2_EURUSD___GBPUSD_15032017-16032017.png

Source: Thomson Reuters Date: 16/03/2017

 

We have been calling for at least three rate hikes in the US in 2017 since Donald Trump’s election victory in November. The jobs market in the US has continued to go from strength to strength, with solid job creation and robust earnings growth underpinning a tightening in labour market conditions. The 235,000 jobs created in the US in February is comfortably above the 145,000 level that is believed necessary to keep up with growth in the labour force, while wage growth of 2.8% is around multi-year highs. Headline inflation also rose to 2.7% in February, its highest level in five years.

We are therefore of the opinion that the risk of the Fed exceeding its current rate hike projections remain tilted to the upside, and expect to see a total of either 3 or 4 hikes throughout 2017. This is, of course, provided the labour market and inflation continue to perform well.

The prospect of an additional 2 to 3 rate increases in the US this year comes in sharp contrast to most major central banks around the world, particularly within the G10, almost all of which remain committed to easing monetary policy. For this reason, we expect a continued strengthening of the US Dollar from current levels against almost every other major currency this year, particularly the Euro and Japanese Yen.

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