The Federal Open Market Committee concluded its two-day policy meeting on Wednesday and as expected, kept the federal funds rate unchanged for the second meeting at between 0.25%-0.50%. Accompanying the March meeting statement were the FOMC’s latest economic projections, including forecasts for the fed funds rate over the next three years.
In what turned out to be a more dovish-than-expected outlook by the Fed, the latest projections expect GDP growth to be slightly weaker in 2016 and 2017 but unchanged for 2018. The US economy is now expected to grow by 2.2% in 2016 instead of 2.4% in December’s forecast. Despite the lower growth forecasts, unemployment is expected to continue to decline in both 2017 and 2018, with the longer run average unemployment rate also revised lower from 4.9% to 4.8%. The inflation outlook was unchanged for 2017 and 2018 but was lowered significantly from 1.6% to 1.2% for 2016. Inflation is forecast to rise to the 2% target by 2018.
More interestingly, the projected number of rate increases by the FOMC has been scaled back with only two rate increases expected this year, compared to four in December. This brings the Fed’s outlook in line with current market expectations. The median forecasts of the fed funds rate are 0.5% lower for 2016 and 2017 at 0.85% and 1.85% respectively, and 0.25% lower for 2018 at 3.0%.
US treasury yields fell on the updated projections with two-year treasury yields declining from 0.98% to 0.86%. The US dollar also fell as the tone of the statement was slightly more dovish than analysts had anticipated. The greenback slipped below 113 yen to a low of 112.33 before rebounding slightly to 112.64 in late US session. It fell even more sharply against the euro, which jumped to a high of 1.1242 dollars.
What took markets by surprise from today’s meeting was the emphasis on the downside risks to the US economy from weaker global growth and Fed Chair Janet Yellen’s doubts about whether the current uptick in inflation is sustainable. Speaking at the press conference after the meeting, Yellen was keen to stress that the US economy has so far been resilient to the slowing global economy but that it remains susceptible to outside shocks.
With regards to inflation, Yellen said it was too early to judge whether the recent rise in core inflation will be sustained and brushed off criticism that the Fed is being overcautious, especially when considering the continued strong jobs growth and healthy household spending. Yellen replied “Such caution is appropriate given short term interest rates are still near zero, which means monetary policy has greater scope to respond to upside than downside changes in the outlook”.
There was one dissent at the March meeting from Kansas Fed President Esther L. George, who voted for a 0.25% increase to the fed funds rate. Further dissent is possible over the next few meetings as committee members debate about the impact of the global headwinds on the US economy. Yellen herself admitted in the press conference that the reason why there was no reference in the statement on the balance of risks to the economy is because committee members could not come to an agreement on where the risks stand. This potentially signals a growing disparity within the FOMC where some members are concerned about the growing risks to inflation while others are more worried about growth losing steam.
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