Fed stays hawkish as June rate hike expectations remain on the table

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The US Federal Reserve Bank’s two-day FOMC meeting concluded yesterday with the central bank releasing a statement on the monetary policy. There were no changes to the Fed’s short-term Fed funds rate which remain in the range of 0.75% – 1.0%.

Fed officials left the benchmark interest rates unchanged and noted that the recent slow pace of economic activity in the first quarter was “transitory,” and focused instead on the continued strength in the labor market and business spending.

As a result, the central bank maintained its view that a rate hike in June is on the table, which all but diminished after the weak March payrolls report and a rather soft GDP growth in the first quarter of the year.

“The Committee views the slowing in growth during the first quarter as likely to be transitory and continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, labor market conditions will strengthen somewhat further, and inflation will stabilize around 2 percent over the medium term,” the FOMC statement showed.

Immediately following the Fed’s statement, the rate hike odds for June rose to 71.6% which was a modest increase in expectations from 67% prior to the event, according to the CME Group’s rate hike probability tool.

CME Group: Fed funds rate probability
CME Group: Fed funds rate probability

The Federal Reserve hiked interest rates in December last year and had signaled two more rate hikes this year. The markets are expecting the next rate hike in June followed by another rate hike in September this year.

In the FOMC statement, Fed officials only made minor changes to the tone of its statement. The FOMC statement acknowledged the slower pace of consumer spending but noted that the fundamentals supporting consumer spending still remained strong.

Latest reports on personal income and spending released this week showed that consumer spending remained flat in the month of March for the second consecutive month. The data indicated that growth was perhaps slowing and remained consistent with the first quarter’s GDP numbers.

Personal income rose just 0.2% as falling prices dragged on the nominal figures. The first quarter GDP growth was the slowest first quarter spending since 2009. The Fed’s preferred gauge of inflation, the core PCE price index was also weaker.

A few weeks before, Fed’s vice chairman, Stanley Fischer said that the recent weakness in consumer inflation was largely due to a decline in prices of cell phone usage and said that it was a one-time shock. The vice-chairman also added back then that there was no evidence that inflation will continue to weaken.

Policymakers are expecting the core PCE to reach 1.9% by the end of the year, but inflation is expected to continue to slide before starting to pick up from the second half of the year.

Market reaction to the FOMC statement

The weak set of data stoked expectations that Federal Reserve officials would strike a dovish tone in the markets. EURUSD rallied earlier in the day in anticipation of a dovish statement, but the markets were surprised by the hawkish tone instead.

The Fed’s decision was also unanimous with no dissents among the voting members suggesting that the dovish members were also getting on board with the pace of rate hikes.

The US dollar closed with strong gains by Wednesday’s close with the biggest declines coming from the Australian dollar which fell 1.51% on the day and gold prices which broke the $1250.00 support and closed with 1.40% losses on the day.

U.S. Dollar Relative Performance: 03/05/2017
U.S. Dollar Relative Performance: 03/05/2017

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