• Statement hardly changed compared to December
• Slightly more upbeat on the economy
• Undershooting of inflation target again emphasized
• Interest rate hike in March de facto off the table
Market reaction: Markets reacted somewhat disappointed after the Fed’s announce-ments. The dollar depreciated against the euro and lost 0.5 cents, the yield of US Treasury bonds decreased by about 4 basis points.
Summary: Yesterday’s statement after the rate decision was more or less equally worded as the one of mid-December. In particular, again the further improvement of the labour market is mentioned. The pace of economic growth is still described as being moderate. Compared to December there is only one real change in the wording. That is the explicit statement of the brightening business and consumer confidence indicators. The monetary watchdogs assume that the economy will continue to grow moderately even after another modest adjustment of the monetary policy (further rise in interest rates). Regarding inflation, the members of the FOMC on the one hand acknowledge the increase observed over the last quarters, on the other hand they however state that inflation still is below the long-term target value of 2% p.a. Hence inflation is expected to settle down somewhere near that value only in the medium-term. FOMC members continue to describe risks to the economic outlook as “roughly balanced”.
Our assessment: Regarding the inflation outlook the monetary committee did not meet our expectations and sounded less hawkish than we had thought. From our point of view it is a misjudgement when saying that the inflation rate will reach the target value of 2% yoy only in the medium-term. According to our estimates, the CPI year-on-year rate will come close to 3% in March and afterwards hover around 2.5% until year-end. Moreover, the private consumption expenditures (PCE) deflator - the Fed’s preferred inflation measure - stood at 1.6% yoy in December with the core rate reaching 1.7% yoy. We expect the PCE deflator to reach 2% in year-on-year terms no later than March oscillating around 2.0% for the rest of the year. With regard to the strong labour market which has already caused a substantial increase in wage growth and possible inflation enhancing measures taken by the Trump administration (tax cuts, import duties) we think FOMC members currently underestimate inflationary risks.
Apart from that we reckon yesterday´s statement to express a wait-and-see mode. The monetary watchdogs are very satisfied with the developments in the economy and on the labour market, they however do not see any danger of overheating. Since in addition FOMC members judge that inflation will need some time before reaching the Fed´s long-run target level they seem to have opted for waiting whether president Trump will take measures which would lead to the necessity of re-evaluating economic prospects and inflationary risks. We therefore conclude that a rate hike is a very unlikely in March. That said the committee seems to stick to its schedule of three rate hikes in 2017.
Since the unemployment rate is set to decrease further in the upcoming months and since the inflation rate - no matter which one of the two CPI or PCE - is likely to settle at or even above 2% yoy no later than March we strongly believe in a rate hike in June. What we can read out of yesterday’s not quite hawkish statement is that in the end rates could be hiked just twice in 2017 instead of three times as indicated by the FOMC in December. Certainly, President Trump has a strong impact on that, as his planed measures might cause a higher inflation in the medium-term.
Bond recommendation: We reckon that there will be two to three rate hikes this year depending on president Trump’s economic decisions. Beside that the inflation rate is supposed to climb and stay higher than the Fed and most market participants currently expect. We therefore see the yield of 10 year US Treasury notes to increase by year-end 2017.
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Financial Instruments/Companies Initial publication date of the recommendation
10Y US Treasury 01/01/1989
2Y US Treasury 01/01/1989
Distribution of long term recommendations (preceding 12 months prior to this publication)
Recommendation Basis: all analysed Government bonds
Not rated 0%
History of long term recommendations (preceding 12 months prior to this publication)
Date 10Y US Treasury
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