Just over a week ago the Federal Reserve deliberated for two days about the correct monetary policy for the world’s largest economy.
The results of these deliberations were then communicated to the world at a press conference hosted by the chair of the Federal Reserve, Janet Yellen.
Intriguingly, her oft-used word “patient” was conspicuously absent from her communiqué – a sign to market watchers that the countdown to the US’s first rate rise in years had begun.
To our minds this seems wholly appropriate given the strong levels of GDP growth, rapidly declining unemployment and positive wage growth. It is believed monetary policy does not start affecting the economy until some 18 months after implementation, so a rate rise in June or September this year should not affect the current growth rate.
Furthermore, much of the economic growth generated in 2014 was achieved while oil prices were around $100 per barrel, whereas they are currently closer to $50 so, if anything, the consumer is in a better place now than last year.
The minutes of the meeting referred to much of the known good news, but then it started tempering the reader’s enthusiasm by discussing the international backdrop, noting overseas weakness (Europe and China), dollar strength (painful for US exporters) and the persistence of lower-than-expected inflation (the deflation monster).
The Fed has traditionally ignored the global economy in its discussions. In fact, on previous occasions it has reiterated that its monetary policy was set with only the US in mind, in effect warning other central banks that they needed to operate in the same manner (probably a direct hint to the European Central Bank, which had been dragging its feet on European quantitative easing).
The real shock from the minutes came when the Fed released the updated version of its “dot plots”, which is a graphic that shows the Fed’s forecasts for the likely path of interest rates in the years to come.
Ms Yellen has been very careful not to convey the wrong message via the language used in the minutes released, but the revised forecasts were clear. Interest rate expectations were cut by 50 basis points, meaning year-end rates are now expected to be 0.625 per cent (rather than 1.025 per cent) with 2017 seeing 3.125 per cent (previously 3.625 per cent).
We suspect that the conclusion to be drawn for investors is that interest rates are going to rise in 2015.
Our feeling is June looks like an appropriate time to implement a rise, but if it is delayed till September, then its impact will not be much different. The changing of the Fed’s forecasts means it believes the rise in interest rates will be a lot slower than originally anticipated, but they remain data-dependent so this could change.
The Fed has been very cautious every step of the way and it looks like this behaviour will not change. The risk to this approach is that the US is now on track for higher-than-expected inflation.