Fed drops "patient" but will raise rates at a slower pace than projected: Analyst's take

SINGAPORE - What Paul Ashworth, chief US economist of Capital Economics, said of Fed's latest statement on US interest rates:

The Fed dropped its pledge that it could be "patient in beginning to normalise monetary policy, paving the way for a June lift-off, but made substantial downgrades to its interest rate forecasts.

The Fed replaced its "patient" pledge with a more vague form of forward guidance, that it will raise the fed funds target range when it has seen "further improvement in the labour market and is reasonably confident that inflation will move back to its 2 per cent objective over the medium term".

The new statement also warns explicitly that there won't be a rate hike in April, allaying a sell-off of US Treasuries or government bonds.

A June lift-off isn't set in stone, but we suspect it would take something pretty dramatic at this stage to alter the Fed's plans.

Fed officials made made downward revisions to their interest rate projections. The median projection for the mid-point of the fed funds target range at end-2015 is now 0.63 per cent, down from the 1.13 per cent projection made in December. Similarly, the median projection for end-2016 was lowered to 1.88 per cent, from 2.38 per cent, and the end-2017 projection was lowered to 3.13 per cent, from 3.63 per cent.

The catalyst for those downward revisions appears to be a rethink about what the economy's long-run equilibrium unemployment rate (or NAIRU) is. Officials now believe that equilibrium rate is between 5.0 per ent and 5.2 per cent, whereas previously the range was estimated to be 5.2 per cent to 5.5 per cent. Presumably the downward revision is because we haven't yet seen a more vigorous pick-up in wage growth. We think this is a mistake.

Our view is that the lack of a pick-up in wage growth is just a matter of timing. It often takes some time for shifts in unemployment to feed into wages, so that fact that it hasn't happened yet doesn't mean it won't begin to show up soon. Accordingly, we wouldn't be surprised if the Fed was eventually forced to backtrack on this change in view.

Based on the Fed's own forecast changes, we are cutting our own forecast for the range of the fed funds rate at end-2015 to between 0.75 per cent and 1.00 per cent, which implies a 25 basis point rate cut in June, September and December (i.e. every meeting when the Fed updates its forecasts and there is a press conference). We previously had a forecast of 1.00 per cent to 1.25 per cent.

Nevertheless, we still expect the range to be up to 2.75 per cent to 3.00 per cent by end-2016, as rapidly rising wage inflation prompts the Fed to hike rates by 25 basis points at each of the eight scheduled FOMC meetings next year.