On Wednesday, US Fed chief Janet Yellen was presented with yet another opportunity to prepare financial markets for a September interest rate hike.
But Yellen sang in the same old dovish tune, repeatedly emphasising on the fact that market participants should not worry too much about when the monetary tightening will begin but rather on the pace or path of these rate hikes. On the latter she said that US monetary policy will remain highly accommodative and totally data dependent.
The market got no new information out of the latest Federal Open Market Committee (FOMC) meeting. This column would label Yellen as still ultra dovish and expects no rate hike in September.
So when will the Fed hike?
Based on the FOMC projections or the “dots”, 15 out of 17 FOMC members see the first rate hike in 2015. Further, the dots also show the there is a possibility of two rate hikes of 25 basis points each this year which naturally implies that we should prepare for a September lift-off. However, if that were the case we would not have seen the Dollar Index getting hammered as the euro, the pound and the Swiss franc all staged heavy gains against the greenback. Further, US equity markets rallied and gold too ended the session in the green – all signs that markets read Yellen’s statement and press conference as being super accommodative. Clearly, much of the market does not see a rate hike coming in September.
On inflation, US dollar and labour market
Yellen sounded pretty confident on achieving the US’ long-term inflation target of two percent. She acknowledged that the recent run-up in energy prices had led to a slight uptick in US core and non-core inflation. On the labour market front, Yellen labelled the recovery as solid but, in order not to sound too hawkish, she topped that off by saying that the labour market recovery could be better still. She wants to see more in terms of US wage growth.
On the dollar, which has considerably appreciated over the last one year against a major basket of currencies, Yellen said that the Fed has no formal policy. This is an interesting statement as, theoretically, a stronger dollar is doing Yellen’s monetary tightening work for her. Thus, there are many strategists who believe that the Fed will talk down the dollar in the coming months ahead.
What’s the market impact?
The latest FOMC statement is bullish for equities, neutral for US bond yields and slightly bearish for the dollar. The market will soon call Yellen’s bluff. Incoming economic data, although much better than the Eurozone and much of the developed world, just does not support a rate hike in September. By December 2017, the Fed projects its short-term interest rate to remain below three percent, which is much below its long run average this far out into an economic expansion.
The message is clear: the Fed will remain highly accommodative. The market should stop relenting about the timing of the first rate hike: it is inconsequential whether it comes in September or December. Yellen will take the “loosest tightening” path in monetary policy history.