The US Federal Reserve is still likely to hike interest rates at one of its next two meetings, although now it looks more likely to be in September rather than July.
That’s the view of Macquarie Wealth Management’s North American Research team which believes an improvement in upcoming US labour market data will likely offset increased uncertainty over the external macro outlook.
Following the FOMC’s June policy meeting earlier this week, something in which committee members lowered their projections for the number of rate increases in the years ahead and US economic growth, Macquarie now attaches a 45% probability of the next rate hike arriving in September, up from 25% seen previously.
July, the meeting that the bank favoured previously, is now seen as a 25% probability, down from 60%, while the FOMC’s December meeting is now seen as a 20% probability.
The bank only places a 10% chance that the next rate increase will not occur until 2017.
“A key driver of our view is our analysis that suggests employment numbers should show an improved picture in coming months compared to what took place in April/May,” says Macquarie.
“Weakness in May created uncertainty regarding hiring momentum and was an important component behind the committee’s decision to hold. Our work suggests the soft report could have been impacted by weather issues. Another factor may have been retirements.”
Macquarie note that after averaging gains of around 80,000 in the preceding 12 months, the number of employed workers aged over 55 fell by 150,000 in May, lopping off 0.4 percentage points from labour force participation in this age category.
“This may help to explain the divergence between the BLS employment report and other labour indicators, which have remained strong,” suggests the bank.
“Looking forward, we anticipate the labour data to show strength. This is a key component of our base case view for a hike in July/September.”
As for the longer-term direction for interest rates, Macquarie forecasts that the FOMC will hike once, on average, every six months until 2018/19, leaving the Fed funds rate sitting at 2%.
“In our view, shifts in the longer-term projections (for the Fed funds rate) are the most important component of the FOMC communications,” says Macquarie.
“Here, there is growing acceptance of an even shallower path (3 hikes, rather than 4) in 2017 and 2018 and of a lower long-term equilibrium level.
“On the latter front, the median estimate fell to 3.0% and has declined by 125 bps since 2012. We believe there is further room for this to decline towards our long-run estimate of 2%.”
The chart below, supplied by Macquarie, shows the evolution in the median FOMC year-ended rate projection for the next three years.
Should the Fed hike at a far slower pace than what current forecasts suggest, the bank believes that this will be supportive of risk assets, including equity markets.
“The willingness to lower projections for the pace of hikes in 2017/18 and the longer-run Fed Funds rate should increase investor confidence that policy is flexible,” suggests Macquarie.
As for risks to the bank’s near-term rate forecasts, it involves something that markets are all too familiar with at present: next week’s UK referendum on whether to remain within the European Union.
“Should the ‘remain’ side win and financial conditions stay favourable, it would increase the likelihood of a hike in July/September. If ‘leave’ emerges victorious and financial conditions tighten, it would increase the likelihood of a longer pause to December or later.”
It’s a commonsense response, although one that demonstrates how many decisions — not just regarding central bank policy — hinge on the outcome of this once in a generation event that will arrive on June 23.
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