U.S. Fed defers rate hike

Taking into account to the recent equity-market turmoil and the economic weakness abroad, the U.S. Federal Reserve (Fed) left the key interest rate unchanged at its September meeting

No rate hike in September …
The Federal Open Market Committee (FOMC) left the federal funds rate, the U.S. key interest rate, unchanged at its 17 September meeting. In its statement, the FOMC explicitly referred to the recent market turmoil and economic weakness abroad (i.e. in major emerging markets: “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.” Only one FOMC member (none at the previous meeting) voted against the decision: Jeffrey M. Lacker would have preferred to raise the target range for the federal funds rate by 25 basis points.

… but FOMC sees somewhat stronger economy
However, the FOMC’s view on the US economy was more favourable than at its July meeting. While FOMC members considered business fixed investment to be soft in July, they said this time that investment having increased moderately. The Fed lifted its GDP growth forecast and reduced the unemployment forecast for this year.
However, the growth forecast for the coming years and the long-term growth forecast were marginally reduced. The unemployment rate forecast for the coming years is marginally lower, as is the forecast for the equilibrium unemployment rate. In line with the current below-target inflation, market inflation expectations moved lower. However, the FOMC inflation forecast for the coming years remained nearly unchanged. So the Fed believes that the turmoil on financial markets and the weakness in emerging economies will not have any lasting effect on the US economy and inflation: “…the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of declines in energy and import prices dissipate.”

Fed member lowered their key interest rate forecasts
Obviously, the Fed members believe that the upswing can last longer, as they do not see any inflation risks building up fast, so they somewhat lowered their “appropriate pace of policy firming”. The average of the central tendency of the appropriate policy rate is close to 0.5 percent at the end of this year, 1.5 percent at the end of next year and 2.5 percent at the end of 2017.

US rates may start moving higher in December at the latest
We leave our forecasts for the federal funds rate and the bond yield unchanged. As to the U.S. key rate, our forecast is now nearly aligned with that of the FOMC (central tendency) whereby interest rates should start moving higher by 25 basis points per quarter from December 2015 onwards, resulting in a 1-percentage-point increase per year. Compared to earlier rate hike cycles, this is extremely moderate. The last rate cycle form June 2004 to June 2006 consisted of 25 basis points at every meeting, i.e. 2 percentage points per year. By historical standards, this interest cycle was already the slowest on record. The slow rate hikes are justified by the asynchronous global business cycle, with higher unemployment rates and lower inflation abroad. The strong US dollar reduces import-price inflation and hence, consumer-price inflation, even more.

Christophe Bernard – Chief Strategist – Vontobel