Richard Jerram, Chief Economist, Bank of Singapore: Four things to note
1. The Fed has pushed back its rate hike expectations.
The Fed was more dovish than expected in its March policy meeting and has pushed back expectations for the path of interest rate increases over the coming couple of years. This more than offsets the impact of removing the word "patient" from its policy statement, especially as Fed chief Janet Yellen said they will not necessarily be impatient. Unsurprisingly, stock and bond markets responded positively to the promise of the Fed staying looser for longer.
2. US dollar strength explains the more dovish stance.
The Fed does not explicitly refer to the exchange rate, but it looks like US dollar strength is responsible for the shift, as a stronger US dollar slows growth and inflation (and the Fed has cut its 2015 forecasts for both variables). We think over the longer term, the US dollar will continue will remain strong, but the pace of appreciation should be more moderate than over the past year.
There will still be a huge policy divergence over the next couple of years between the Fed and the European Central Bank and the Bank of Japan, which should be positive for US dollar.
As seen as in the chart above, the Fed essentially reduced its expectations for the Fed Funds rate (its key interest rate) by around 50 basis points (half a per cent) for each year. Now it sees rates at 3.125 per cent by end 2017 compared to 3.625 per cent previously.
3. The Fed is still much more hawkish than the markets.
The Fed is more dovish than before, but it is still much more hawkish than market expectations and we are concerned that rising US wages could force it to reverse its relaxed position on inflation before the end of the year.
The Fed still has long-term neutral interest rates (meaning where it thinks rates can go while still having neutral effect on US inflation) at 3.75 per cent - far higher than financial markets which see a peak in the interest rate cycle of around 2 per cent.
Now that "patient" is gone a June rate hike is possible but unlikely. It looks like the economic data will need to improve rapidly in order for the Fed to move. September now looks more probable, with another rate hike in December.
4. US job market is key to Fed
The Fed is saying that labour market improvement is the key to policy, and that it needs to be "reasonably confident" that inflation is heading back to the 2 per cent target. This is a dangerously backward-looking approach considering the time lags in the system, but the Fed seems comfortable taking the risk of a significant inflation overshoot in order to avoid the risk of deflation.
The Fed has cut its estimate of how low the jobless rate can fall before the US hits full employment. Previously the range was centred on 5.35 per cent and this is now 5.1 per cent. The Fed seems to be saying that wages have not increased by much, so full employment must be lower than we thought. However, it has also (again) cut its forecasts for the unemployment rate, so it still has the economy at full employment by the end of this year.
Remember, the Fed has consistently under-estimated the improvement in the job market.
Overall we have to recognise that the Fed is responding to USD strength and delaying the schedule for interest rate hikes. However, we are concerned that this could reverse if tight labour markets start.
DBS Group Research: Two things to note
1. Markets took bad news as good
As expected, the Fed said rate liftoff will become data-dependent going forward, having removed the time-based promise to remain “patient” from its statement yesterday. Less expected, the Fed said the data have softened of late and inflation has fallen further below its 2 per cent target.
Markets again took bad news as good.
For a fifth year in a row, the Fed has downgraded its growth forecast for the year ahead from overly-bullish expectations built up towards the end of the previous year. On average, officials now expect 2015 GDP growth of 2.5 per cent compared to 2.8 per cent in December. Forecasts for 2016 and 2017 were lowered by equivalent amounts.
The Fed now expects headline inflation will run at a 0.7 per cent pace at the end of this year, well below the 1.3 per cent forecast made December.
2. Fed could delay rate liftoff till after September
Fed downgrades to growth and inflation outlooks now put their views closer to our own. We expect 2.25 per cent 2015 growth, not much different from the Fed’s 2.5 per cent forecast. We are less certain that inflation will rise however.
As noted yesterday, overhangs remain in labour markets, capital markets and household balance sheets that could keep consumption, investment, wages and broader inflation low for a long time to come.
In any event, with Fed expectations for core inflation to remain below 2 per cent until 2018, the obvious question becomes: what’s the rush to hike now? Why is there such a focus on a June vs September liftoff?
Our sense is this too will be revised in coming months. We think growth will fall a bit short of even current Fed expectations and that core inflation won’t rise much this year or next.
Add to this the fact that the Fed’s two key hawks will retire this month and its rate-setting committee's consensus could have a much more dovish feather in its cap before September rolls around.