Tighter financial conditions could pose risks to the outlook, and the conditions for liftoff simply haven’t yet been met. The Fed will take a pass on raising rates at the September meeting but will keep hope alive that day is coming soon.
That’s the concise view of Ellen Zentner, Ted Wieseman, Paula Campbell Roberts and Robert Rosener, Morgan Stanley’s US economics team, on what they believe will be the likely outcome of next week’s highly anticipated US FOMC meeting.
The quartet expect that the committee will pass on the opportunity to raise interest rates, acknowledging that there has been a recent tightening of domestic financial conditions.
In the accompanying policy statement, they suggest the FOMC’s assessment on current conditions will portray a dynamic of domestic strength versus external headwinds.
As the FOMC does every second meeting, it will also release its revised economic projections, along with the closely-watched “dot” chart that plots committee member expectations for the future path of the Fed funds rate.
On economic growth and core PCE inflation, Morgan Stanley believes the FOMC will revise down its forecasts for both 2016 and 2017.
Fitting with the expected downgrade to inflation and growth expectations, they suggest that the forecast pathway for rates will be lowered also, although a majority of members are likely to indicate that a rate hike in late 2015 is still on the cards.
Here’s their assessment on what to expect:
“As the September meeting comes and goes with no rate hike announcement, the dots are likely to move lower in 2015, with a lower modal expectation centered around 0.375%, indicating the majority expect one rate hike in 2015.To be sure, we believe Chair Yellen’s dot was already centered on one hike at the June meeting and she has given no indication that she no longer thinks a hike in 2015 is in the cards. Eric Rosengren, President of the Boston Fed, is one participant we see at risk of moving the expected first hike into 2016, and there are certainly other more dovish voices that could move as well—namely, Governors Brainard and Tarullo”.
The chart below contains a lot of information, but it repeats what Morgan’s discusses above, only in graphic form. The individual grey dots represent each FOMC’s view on the expected path for the Fed funds rate in the years ahead as of June this year. The yellow squares represent the median view as of June, with the green squares the median level expected by Morgan’s in the September projections.
The dotted blue line is Morgan’s forecast for the outlook for the Fed funds rate, while the dotted orange line is current market pricing. Clearly both, especially the market, are significantly below where the committee saw the path for interest rates in June.
So if the committee pass on the opportunity to hike in September, when will they go?
“We maintain our expectation the Fed gets it done in December,” says Morgans.
Here’s their excellent synopsis on the BASIS for their call:
“We are encouraged by a Fed that continues to stick with the message of an intent to raise rates this year, but they won’t do it bull-headedly. The data must inform them that the time is right, and they’ve been bending to the data as much as possible throughout the year. Now, the last hurdle is simply perceiving the downside risks to inflation have receded. That doesn’t seem like a heroic ask, but the mighty dollar is a blunt instrument and its seemingly uncontrollable ascent has only abated once: when the data on US economic activity rolled in 1Q and the Fed pushed off its intent to hike rates at mid-year.
In our Autumn Outlook, our baseline forecast does not detail a repeat of this. We believe there is enough momentum in the economy to win this tug of war with what have been extraordinarily difficult external headwinds. The Fed may not be able to get far in this policy tightening cycle, but they are determined to get off zero”.
The FOMC’s rate decision, policy statement and economic projections will be delivered Friday morning next week at 4am AEST. Chair Janet Yellen will also participate in her bi-meeting press conference following the conclusion of the meeting.
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