The messages from the March FOMC meeting reveal a US rate-setting committee that is much more attuned to the risks to US growth from abroad and thus willing to approach monetary policy normalisation more cautiously. There were signs of this greater focus on risk management considerations in the communications in between FOMC meetings, particularly in speeches by Governor Brainard and President Dudley; it appears their concerns about downside risks are shared more widely on the committee.
As such, the latest statements are notably dovish for a FOMC that remains intent on raising policy rates this year. For example, while the policy statement did not bring back a full assessment of the risks to the outlook, it nevertheless noted that “…global economic and financial developments continue to pose risks”.
Inflation: below target and likely to stay there for now
Chair Yellen elaborated on these risks in her media briefing after the March FOMC meeting, highlighting a number of countries experiencing slower growth. In addition, despite the firming in inflation over recent months, the policy statement continues to emphasise that inflation is running below the committee’s objective, that it is expected to remain low in the near term and that market-based measures of inflation compensation remain soft.
The Summary of Economic Projections similarly reflects the committee’s growing appreciation of downside risks and the restraining effects of slowing global growth. Judging from the median economic projections, the FOMC continues to expect above-trend growth this year and next and a gradual return of inflation to two percent.
Only two FOMC rate increases this year
However, to achieve these outcomes, committee members foresee a notably flatter path of policy rates. The median policy rates projected for year-end 2016 and 2017 each came down by 50bp to reflect 50bp of policy tightening this year and 100bp next year. Tellingly, the highest projections for 2016 and 2017 came down by even more than the median projections – even the more hawkish members seem to appreciate the challenges associated with sustaining interest-rate increases in an environment of weakening global growth and divergent monetary policy stances among the major central banks.
For some time now, I have expected the committee to only raise rates twice this year, bringing the interest rate on excess bank reserves to 100bp by the end of the year. I see no reason to change this call after the March FOMC meeting. Growth this year has been unimpressive, tracking a bit above trend for the first quarter. And as I have written previously, there are several variables that may be signaling downside risks to growth such as the deceleration in services sector activity surveys, tighter bank lending standards for commercial and industrial loans and declining corporate profitability.
On the watchlist: wages, consumer spending and global growth momentum
Still, the FOMC can feel confident that the economy has been fairly resilient in the face of headwinds from abroad. Members are also likely heartened by the easing measures taken by other central banks, particularly as these measures have not led to US dollar appreciation. Furthermore, even if growth is slowing towards trend, there is growing evidence that inflation is gradually firming. This may continue if there is a further drop in labour market slack and if oil prices do not revisit their February lows.
As for the timing of an additional rate increase, June remains a possibility, but a lot has to “go right” to bring this about. The committee will want to see that the recent firming of inflation does not prove short-lived and that inflation expectations continue to move higher. It will also seek confirmation that growth is not slowing to a below-trend pace. In this regard, some of the key variables to watch include payrolls, consumer spending – which has been running on the soft side recently – and surveys of services sector activity. In addition, indicators of global growth momentum bear close watching; here as well, the news has not been particularly encouraging, judging by recent global PMI data.