• Key rate range raised by 25 basis points to 0-75% - 1.00%
• Fed holds out prospect of two more interest hikes in 2017
• The 2018/2019 tentative key rate path is de facto more aggressive than in December
• Shrinking of the Fed's massively expanded balance was discussed
Market reaction: In reaction to the interest decision, the dollar lost more than one cent against the euro, the exchange rate reached 1.073 EUR/USD. US government bonds booked gains over all maturities. The respective yield dropped by 8 basis points, in the case of 10-year government bonds this means a decline from 2.58% to 2.50%.
Summary: As expected, the US Fed raised the key rate range by 0.25% to 0.75% - 1.00%. The decision was reached with one dissenting vote by Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, who voted against the increase. The statement accompanying this interest decision differs markedly from the remarks made in the course of the last decision. Particularly the statements regarding the inflation were adjusted. On the one hand, the Fed acknowledges that the inflation target has been reached, on the other the focus now lies on keeping the inflation rate close to this target. The core inflation rate was once again cited as a relevant factor. Moreover, the bank once again points out that the labour market has continued to improve further. Employment growth over the past few months has been described as solid. The Fed once again considers the risks for the short-term economic outlook as roughly balanced.
According to the new projections of the expected key rate path, which were also pub-lished, the majority of the currency guards still considers a total of three interest hikes – each by 0.25% - in 2017 as appropriate. Furthermore, the FOMC projects three hikes in 2018 as well. For 2019, the expected key rate path indicates an increase of 0.875% in total, which would equal three and a half hikes. In this projection, the key rate would reach between 2.00% and 2.25% by the end of 2018 and climb to 3.00% until the end of 2019. The key rate, assumed to be neutral in the long term, is seen at 3.00%, as in December.
Projections regarding the growth of the real gross domestic product, the inflation rate as well as the unemployment rate for the period between 2017 and 2019 were left virtually unchanged. The FOMC projects an unemployment rate of 4.5% for each of the three years. This figure is now merely 0.2% below the rate considered neutral in the long term, due to the fact that the latter has been lowered from 4.8% to 4.7%.
During the press conference, Mrs Yellen stated that the projections do not include any effects of potential changes in the economic and fiscal policy as of yet. She furthermore stated that it is still not possible to assess how such policy changes could affect the econo-my, the labour market and the inflation.
As far as the Fed's still massively bloated balance is concerned, Yellen mentioned that there has been discussion about the appropriate point in time to suspend the re-investment of coupon payments and maturing bonds. According to Yellen, no decision has been reached as of yet, and the topic will be discussed in greater depth at the next meetings.
Assessment: In our view, the communication regarding the interest decision is very balanced. The monetary policy statement, the projections as well as the statements made by the Fed president all express both ‘dovish’ and ‘hawkish’ positions. It is certainly 'dovish' that the currency regulators will orient themselves more on the core inflation rate in their inflation assessments. Another 'dovish' aspect is Yellen's statement to the effect that yesterday's interest hike does not signal any changes in the expected interest rate path, which is considered appropriate. Her assertion that the frequency of interest hikes of one hike per meeting in the last phase of interest increases from 2004 to 2006 is, for the time being, practically off the table is likely an attempt to dampen speculations on a considerably faster tightening of monetary policy. That said, there are also indications that the 'hawks' on the board asserted themselves in some points. One example is the fact that the word ‘only’ has been dropped from the statement: instead of ‘only gradual increases in the federal funds rate', the FOMC members now consider the wording ‘gradual increases in the federal funds rate' to be appropriate. Moreover, we also consider the stressing of the fact that the Fed's inflation target is symmetrical to be on the 'hawkish' side. Another indicator suggesting a move towards a more 'hawkish' stance is the key rate path itself. While at first sight the path remains unchanged for 2017 and 2018, a closer look reveals adjustments. The number of central bankers who considered a key rate range of at least 1.25% - 1.50% to be appropriate for the end of 2017 has increased from eleven to fourteen. Regarding the end of 2018 now only three FOMC members consider a key rate range below 2.0% - 2.25% to be appropriate. In December seven members had still supported this notion. If only one more FOMC member switches to the camp of members who consider a key rate range of at least 2.25% - 2.5% to be appropriate, the median expectation would change from three to four interest rate hikes in 2018.
In our opinion, the Fed cemented its intention yesterday to increase the key rate three times both this year as well as in 2018. Unlike in the preceding years, the risk is probably no longer mainly in the possibility that we may see fewer hikes, but rather in the potential for additional increases. This view is also clearly support-ed by the fact that so far no potential positive effects of an expansive fiscal policy have been taken into account. If President Trump implements the announced substantial tax cuts for private households, this step would – from our point of view – result in a substantial risk of more rate hikes than currently expected by the FOMC, especially considering the fact that the labour market operates at full capacity. With these factors in mind, we retain our previous assessment and assume that there will indeed be five more interest hikes until the end of 2018, the next one likely in June.
Bond recommendation: From our point of view, the market reaction to yesterday's interest decision seems exaggerated. Several market participants have apparently speculated on even more 'hawkish' undertones or hoped for another upwards-adjustment of the expected key rate path. As it is, it seems more rather than less likely that the Fed will raise the key rate at least three times both this year and next. Our assumption of a solid development on the labour market and our projected inflation path both suggest that the yield for US government bonds will continue to increase in the months ahead.
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Financial instrument/company Date of initial recommendation
10y US Treasury 01.01.1989
2y US Treasury 01.01.1989
Distribution of short-term recommendations (of the 3 months prior to this publication)
Recommendation Basis: all analysed government bonds
No recommendation 0%
History of short-term recommendations (last 12 months prior to this publication)
Date 10y US Treasury 2y US Treasury
10.03.2017 Hold Sell
03.03.2017 Hold Sell
13.01.2017 Sell Hold
16.12.2016 Hold Hold
25.11.2016 Hold Hold
18.11.2016 Hold Hold
11.11.2016 Hold Sell
23.09.2016 Sell Sell
05.09.2016 Sell Sell
01.07.2016 Sell Sell
27.05.2016 Sell Sell
Source: RBI/Raiffeisen RESEARCH
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Creation time of this publication: 16/03/2017 08:42 AM (CET)
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Creation time of the publication in German: 16/03/2017 07:47 AM (CET)
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