The Fed Didn’t Raise Rates Again – Shocker!

The recent meeting of the Federal Open Market Committee concluded – drum roll please – with no rate hike. Many had anticipated this result and it didn’t come off as a surprise especially considering the Brexit vote is next week and economic conditions haven’t improved.

The main issue remained the revised outlook of the FOMC members regarding the U.S. economy and the cash rate. On the former, the FOMC revised down GDP growth rate but core inflation was slightly revised up for 2016. As for the latter, the FOMC mostly revised down the dot plot for the subsequent years but the median for 2016 remained unchanged – i.e. still two rate hikes are possible this year.

FOMC outlook

Source: FOMC

The rising concerns over a possible recession still loom and could keep holding back the Fed from raising rates this year. Looking forward the Fed even lowered its terminal rate outlook to 3% — bear in mind that the current terminal rate is below the rate the Fed predicted for 2017 back in the March 2015 meeting. So as the Fed keeps lowering the terminal rates – and it has lowered it in the past three consecutive times – the trajectory of the cash rate will keep falling; this means the Fed expects low rates are here to stay for extend periods of time. The Fed also released a dovish statement. But then Chair Yellen in her press conference remained adamant to keep the door open for a rate hike as soon as July. So if the next NFP report shows a much better growth in jobs (say 200K), wages continue to pick up and the British vote keeps Britain in the EU then we could still another hike in the next meeting.

But I remain very skeptical. Given the state of the U.S. economy, the weakness in the global economy the asymmetric risk between raising rates and keeping rates low a bit longer, the uncertainty of the U.S. political environment, it seems unlikely to see another rate hike anytime soon (if at all this year). So why keep the door open for July hike? Three reasons: For one, I think the Fed still wants to adjust the market towards a possible hike and keep the option on the table. Second, there is still pressure – mainly from banks – to raise rates so this statement serves as a way to reduce this pressure. Finally, the Fed dosen’t want to come off too bearish and have an adverse impact by suggesting matters are so dire, the economy won’t withstand a rate hike.

Bottom line

No rate hike – no surprise. The released a dovish statement and lowered rates in the dot plot for 2017 and onward but still left the door open for a rate hike this year, which for now, given the current market conditions, seems unlikely.

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