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First Fed Rate Hike Likely Postponed to September

As expected, the FOMC dropped the word "patience" from its monetary policy statement. At the same time, it lowered its forecasts for growth, inflation and the long-run unemployment rate.

In a continuation of its remarkably transparent process of monetary policy normalization, the US Federal Reserve's Open Market Committee (FOMC) changed its policy statement at the 18 March meeting and removed the so-called forward guidance on its policy rate. So far, it had been stating that it could "be patient" before beginning to normalize policy – a phrase meant to signal to financial markets that no rate hike was to occur over the following two Fed meetings. By removing this reference, the Fed is now basically free to hike the policy rate at any meeting from June onward, depending on its assessment of the outlook for employment and inflation (an April hike was explicitly mentioned as being very unlikely.)

Growth, Inflation and NAIRU Estimates Lowered

While the Fed has opened the door for rate hikes, the assessment of the economy by the FOMC's meeting participants has become somewhat more subdued. First, the FOMC's assessment of current economic momentum was dampened: instead of referring to a "solid pace" of the expansion, the Fed said that growth had "moderated somewhat." An implied reference to the impact of the strong dollar was also included by pointing out that "export growth weakened." The FOMC also provided an update of its longer-term economic projections. Forecasts for economic growth were lowered by 0.3 percent points to 2.5 percent in 2015 and by similar amounts for 2016 and 2017.

The FOMC's forecast for personal consumption expenditure (PCE) inflation was lowered by a substantial 0.6 percent points to 0.7 percent YoY in 2015, though the higher 2016 and 2017 forecasts remained largely unchanged. Finally, the median forecast for the "equilibrium" (or non-accelerating inflation) unemployment rate (NAIRU) was lowered to 5.1 percent, a rate which the FOMC expects to be reached in Q4 2015. The combination of a lower NAIRU estimate and a lower inflation forecast suggests the Fed is not at all worried about a tighter labor market putting too much upward pressure on inflation at this point.

FOMC Unlikely to Have Enough Evidence of a Rising Inflation Trend by June

In fact, the FOMC stated that it would only hike rates "when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term." (That said, Fed Chair Janet Yellen stated in her press conference after the Fed meeting that a faster rise in wages was not a prerequisite for a rate hike. Depending on the measure, the latter are rising between 2 percent and 2.5 percent YoY).

Core inflation, as measured both by the consumer price index as well as the deflator for core personal consumption expenditures, has softened since May 2014, and it remains to be seen whether the signs of stabilization visible in January data will be confirmed over the coming months. Given the prevailing strength of the USD and the possibility of second-round effects of lower energy prices, it may take some months until a sustainable upward turn in core inflation becomes evident in the data. Even if inflation bottoms out in April (the data which the Fed will have at its disposal in June), there is unlikely to be strong evidence that the trend is rising toward the Fed's 2 percent target. This is the main reason for changing our forecast for the first rate hike from June to September 2015, although a June hike cannot be excluded if the US economy re-accelerates convincingly in the coming months.

Slow Trajectory for Rate Hikes After September

Another important change in the FOMC's outlook was a marked lowering of the trajectory of expected rate hikes. The median forecast for the Fed funds rate was lowered by 50 basis points (bp) to 0.625 percent at the end of 2015, and by about 60 bp to 1.875 percent at the end of 2016. Assuming that the core members of the FOMC (i.e., Fed Chair Yellen and Vice-Chair Fischer) are fairly close to the median, this suggests to us that we are unlikely to see more than two rate hikes in 2015, and that rate hikes will be gradual in 2016, especially if growth abates as the FOMC and we expect, and if the USD stays strong. In sum, we therefore expect the Fed to proceed cautiously toward policy normalization.

Forecasts of Fed meeting participants (March 2015)

Indicator Forecast Change Indicator Forecast Change
GDP growth Unemployment rate
2015 2.50 down 2015 5.10 down

2016

2.50

down

2016

5.00

down

2017

2.20

down

2017

4.95

down

Long-run

2.15

none

Long-run

5.10

down

Inflation Fed Funds rate

2015

0.70

down

2015

0.63

down

2016

1.80

down

2016

1.88

down

2017

1.95

up

2017

3.13

down

Long-run

2.00

none

Long-run

3.75

none

Note: Figures refer to Q4 of the relevant year. Inflation and GDP in percent YoY, unemployment and Fed Funds rate in percent. Numbers refer to the mid-point of the central tendency of forecasts. Changes are relative to the December 2014 forecasts. Fed Funds rate forecasts are the median forecast of the mid-point of the target range and include the full set of forecasts.

Source: Federal Reserve, Credit Suisse