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GOLDMAN: US rates hikes are on the agenda

Getty Images.

With the US economy growing above trend, unemployment at just 4.9% and inflationary pressures now moving higher, the US Federal Reserve is now close to meeting its dual mandate on employment and inflation, ensuring rate hikes will be on the agenda at the FOMC’s current policy meeting.

That’s the view of Silvia Ardagna, Robin Brooks and Michael Cahill, economists at Goldman Sachs, who suggests that should the FOMC wait too long before lifting interest rates again, “it could run the risk of letting the economy over-heat, only to then hike rates much faster and potentially to a higher level.”

While markets are eagerly awaiting the FOMC’s updated “dot plot”, the individual assessment from its members on the likely level of the fed funds rate in the years ahead, Ardagna, the Goldman Sachs’ economists suggest that investors should be paying more attention towards the Fed’s communication around the likely timing of the next rate hike, along with the pace of future hikes, communicated in the FOMC’s policy statement and chair Janet Yellen’s press conference.

“Ahead of this week’s meeting, the market is again putting more weight on the Fed dots’ downward revision than on the Fed’s communication around the timing of the next hike and the pace of the tightening cycle. We disagree with this market view,” say the trio.

The big picture is that the upcoming FOMC meeting is likely to be more comparable to that in October 2015, when the Fed took the lead and led investors to revise upward the probability of a hike in December, than to the September meeting, when an excessive focus on downside risks and a downward revision of the dot plots led the market to sell risk and financial conditions tightened.”

Though Goldman expect the FOMC will lower its median projected pathway for rate hikes this year, down to three from four offered in December 2015 – still well above the one hike currently expected by markets – it expects Janet Yellen will use her media conference, 30 minutes after the FOMC policy statement and updated economic forecasts are delivered, to narrow the gap between FOMC and market expectations.

The chart below, supplied by Goldman, reveals the current divergence between rate hike expectations for the market and those offered by the FOMC. Goldman’s expectations for the March Fed dot plot are shown in black.

“We think that Chair Yellen will use the press conference to narrow the gap between the market’s and policymakers’ views,” say Ardagna, Brooks and Cahill.

“Preparing the market for another ‘hike it and like it’ might be a better option at the current juncture. Not only have data moved in the right direction, but financial conditions, a metric that has occupied an important place for many Fed speakers, have eased back to their level in December.”

They also suggest that risks posed by emerging markets – particularly China – have also diminished. US dollar strength has also not eventuated despite additional monetary policy easing from the European Central Bank and Bank of Japan, an outcome along with China’s pledge to not make a sharp devaluation the renminbi lessens the likelihood of a dovish outcome in Goldman’s opinion.

The bank expects the FOMC to lift the fed funds rate target by 25 basis points in June, although admit that “a hike in April is not inconceivable”.

The FOMC statement and economic projections will be released at 5am AEDT this Thursday. Janet Yellen’s scheduled address will begin at 5.30am AEDT.

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