If you’re expecting two or more US interest rate hikes this year, prepare to be disappointed.
There’s only likely to be one, in December, leaving the Fed funds rate at just 0.5-0.75%.
That’s the view of Joseph Capurso, senior currency strategist at the CBA, who believes the US rate tightening cycle will now be longer, and lower, that what had previously been expected.
Here’s an excerpt of a research note he released on Thursday morning.
We now expect the FOMC to implement a more drawn-out tightening cycle. We expect the FOMC to hike by only 0.25% in December 2016, 2017, 2018, 2019 and 2020. Previously we expected increases in the Funds rate in June and December 2016, 2017 and 2018. Under both our new and old forecasts, the terminal rate of the target range of the Funds rate is 1.50-1.75%.
Currently the FOMC forecasts that the Fed funds will sit at 3.25% over the longer-term, some 3% higher than its present level of just 0.25-0.5%.
To recap, here’s the FOMC’s infamous “dot plot” from its March policy meeting, containing the year-end forecasts for the level of the Fed funds rate from individual committee members.
To many, including financial markets which currently expect it to sit around 1% well into 2018, the expectation that rates will sit above 3% beyond 2018 ahead seems more like a fantasy rather than reality.
Capurso has sympathy with this view, suggesting that risks to his own forecast are to the downside, not upside.
“Our conviction that the FOMC will push the Funds rate target range as high as 1.50-1.75% is not high,” he says, suggesting that “there are risks that may prevent the FOMC from tightening beyond a target range of 1.0-1.25%.”
The risks that Capurso refers to are weak wages growth despite tightening labour market conditions, “very low” inflation expectations and weak business investment, with firms preferring to pay out profits through dividends or initiating buybacks rather than reinvesting in their businesses.
Capurso is essentially saying that the risk is the Fed will miss on its inflation mandate of 2% due to a lack of underlying drivers to spur on price pressures.
That fits with what we’ve seen over the past year where the Fed has all but achieved its other policy mandate — full employment — without being able to achieve any meaningful lift in inflation expectations.
The saying “between a rock and a hard place” comes to mind. Rates are still at extraordinarily low levels, the labour market is tightening, yet there’s no sign that inflation is returning.
If Capurso and financial markets are proven to be correct, it will not only have implications for asset prices globally but also policy decisions from other major central banks, including the Reserve Bank of Australia.
Given the unprecedented levels of monetary stimulus delivered by central banks around the world following the global financial crisis, and the subsequent sluggish response from economic growth and inflationary pressures, it’s little wonder that so many doubt whether the Fed’s forecasts will come to fruition.
Can the Fed really tighten rates aggressively as other major central banks are easing?
Maybe so, but the track record of other central banks who attempted to do this in prior years is hardly stellar, with all forced to reverse course and loosen policy to ever greater levels.
Perhaps that, rather than a slower and lower tightening cycle, is truly the greatest risk when it comes to the outlook for US interest rates.