United States Monetary Policy June 2016

United States

United States: Fed in no rush to raise rates in June due to weak jobs report and Brexit vote

June 15, 2016

At its monetary policy meeting that took place on 14–15 June, the Fed’s Open Market Committee (FOMC) recognized that the pace of improvement in the labor market has slowed at a time when growth in economic activity appears to have picked up. As a result, the Fed announced that the federal funds target rate would remain within the current range of between 0.25% and 0.50%, which was a decision widely expected by analysts and market participants. Underpinning June’s decision was a poor jobs report for May—the economy created just 38,000 jobs, the worst result since September 2010—and the Fed’s view of headwinds in the form of sluggish global growth, soft fixed investment in the wake of low oil prices and persistent low inflation. Exports are rebounding, but the UK’s 23 June referendum on whether to stay in the EU could prompt another round of global financial disruptions.

Although Chair Janet Yellen kept the prospect of a rate rise in the coming months alive, she warned that future interest rate increases are likely to unfold at a slower pace. Moreover, reflecting the Fed’s more cautious stance, all 10 members of the FOMC voted to leave the interest rate unchanged, which contrasts the two previous meetings in which Esther L. George, President of the Kansas City Fed, had voted to raise interest rates. In an update to its economic projections, the Fed left its forecast unchanged for the average funds rate this year as Fed officials are still anticipating two hikes, totaling 50 basis points. That said, the number of FOMC participants expecting just one hike this year went from one in March to six in June, which tilts March’s balance away from two hikes with the possibility of three, to two hikes with the possibility of one. For 2017, the Fed trimmed its interest rate forecast to 1.6% from 1.9% in March, which implies that it may only raise rates twice next year, compared to the three times projected in its previous forecast. The Fed’s outlook for interest rates is now more in line with analysts’ views. Lewis Alexander, Chief U.S. Economist, and his team of economists at Nomura commented:

“The FOMC’s forecasts for 2017 and 2018 came down even more. In the post-FOMC meeting press conference, Federal Reserve Chair Yellen acknowledged that FOMC participants continue to lower the path of interest rates that they think will keep the economy ‘on an even keel’. Our outlook for policy has not changed. We still expect one hike this year, and two hikes in 2017 and 2018. We think the most likely timing for the next hike is September, which reflects our judgment that the economy will grow faster in the second half of this year than its 1.1% pace in Q4 2015 and Q1 2016.”

U.S. monetary policy makers would need to see more decisive evidence in the coming weeks that the dismal jobs data in May was a one-off rather than a serious setback if they are to feel confident enough to lift rates in the July meeting.

Regarding the Brexit vote, Chair Yellen said that it had indeed weighed in the Fed’s policy decision. She said that a UK from the EU could have significant consequences for the U.S. economic outlook and financial developments. Regarding the Fed’s assessment of the Brexit vote, Mikael Olai Milhoj, Senior Analyst at Danske Bank, stated:

“We still think that the outcome of the UK’s EU vote remains highly important for Fed’s hiking cycle. If the UK votes to leave the EU, the second hike could be postponed even further, as a ‘Brexit’ would likely result in slower global growth to which the US would not be immune.”

In her address to a Senate Banking Committee on 21 June, Chair Janet Yellen stated that she sees “considerable uncertainty” regarding the U.S. economic outlook, and pointed out that weak hiring numbers and soft investment are the evidence that risks remain on the horizon. When asked about the Fed’s recent monetary policy decision, Janet Yellen said that, “proceeding cautiously in raising the federal funds rate will allow us to keep the monetary support to economic growth in place while we assess whether growth is returning to a moderate pace, whether the labor market will strengthen further, and whether inflation will continue to make progress toward our 2 per cent objective.”

The U.S. Federal Reserve left its interest rate forecast unchanged for this year at 0.9%, which is in line with the Consensus view of our panelists. The panel sees the federal funds rate averaging 0.88% at the end of 2016. For next year, the Fed trimmed its interest rate projection, which is now more in line with our panelists’ forecasts. The Fed projects, on average, that the federal funds rate will end 2017 at 1.6%. The Consensus view among analysts is that the Fed funds rate will end 2017 at 1.67%.

Author:, Senior Economist

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United States Monetary Policy Chart

USA Monetary Policy June 2016 1

Note: Total assets on the balance sheet of the Federal Reserve in USD billion and Federal Funds Target Rate in %. Current rate set at a range of between 0.25% and 0.50%.
Source: Federal Reserve

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