June Rate Hike in Sight. May FOMC Meeting

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Summary:

  • Officials leave the short term rates at 1.50% – 1.75%
  • Federal Reserve on track to hike rates at the June FOMC meeting
  • Officials willing to tolerate inflation overshoot beyond 2%
  • Further rates hikes for the rest of the year to be determined by incoming data

The Federal Reserve Bank held its monetary policy meeting last week. As widely expected, the central bank held its main short term funding rates unchanged at the end of the two-day monetary policy meeting on Wednesday.

The central bank acknowledged that inflation was rising but did not offer much insight. The sudden increase in consumer prices and the recent slowdown in the U.S. economic expansion in the first quarter did not see any references being made by officials.

The decision to keep interest rates steady at 1.50% – 1.75% was a unanimous decision. The FOMC statement did not give much details about the possibility of a faster than expected rate hike.

Policymakers only made a few changes to the language of the FOMC statement compared to the March monetary policy meeting. The statement acknowledged that on a 12-month basis, inflation and core inflation was moving closer to the 2% inflation target.

This suggested that the FOMC was on its way towards normalizing interest rates after initially interest rates fell to historic lows. In March, the FOMC had also released its economic projections. This showed that officials were divided on whether they expect interest rates to rise a total of three or four times a year. Overall, officials indicated their preference that interest rates could rise three times this year.

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Fed watchers predict that the central bank will hike interest rates again at the June FOMC meeting. However, if the Fed follows through with a June rate hike, the subsequent rate hikes were seen to be difficult to predict currently. Analysts are also divided on whether the Fed will hike rates three or fourt times this year.

Recent economic data showed that the U.S. economy was still expanding but the pace of economic growth was seen to be rising at a slower pace. According to the commerce department, the U.S. gross domestic product was seen rising 2.3% during the first three months of the year.

This was a slower pace of expansion compared to the previous quarter ending December 2017. On the other hand, inflation data showed that the Fed’s preferred gauge of inflation, the core PCE price index reached 2%.

The FOMC statement said that annual inflation “is expected to run near the committee’s symmetric 2 percent objective over the medium term.”

Based on the FOMC statement, the central bank had reintroduced the word “symmetric” suggesting that officials are willing to wait for inflation to overshoot the central bank’s 2% inflation target. This comes amid the Fed which had maintained an optimistic view when inflation was weaker and called it “transitory.”

The May FOMC statement also removed the phrase “the committee is monitoring inflation developments closely,” which was seen in the April monetary policy meeting.”

The overall conclusion from the monetary policy meeting held last week was that the FOMC is willing to tolerate higher inflation, above 2% in the short term. With the Fed expected to hike rates at the June FOMC meeting, this leaves two more rate hikes for the rest of the year.

Much of this will depend on how the U.S. economy advances as well as inflationary pressures that could determine the outcome of the number of rate hikes for the rest of this year.

Following the FOMC statement, the U.S. dollar was little changed. The index which was already bullish heading into the Fed’s meeting was seen rising to a 5-month high before easing back later in the day. The main technical resistance is seen at 92.75 which could put downside pressure on the USD index.

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