“The US Federal Reserve looks to be laying the ground work for its second interest rate increase of 2016, and the fourth overall of this policy-tightening cycle, judging by the market’s reaction to Wednesday’s policy meeting,” comments Russ Mould, investment director at AJ Bell. “If that view is correct then investors had better hope the central bank is accurate in its view that the weak first-quarter US GDP growth figure is just a blip.
“Chair Janet Yellen and the Federal Open Markets Committee left the Fed funds target range unchanged at 0.75% to 1.00%, as had been widely expected. Yet futures markets priced in a greater chance of a 0.25% increase in US headline borrowing costs after the meeting, according to the CME Fedwatch tool:
Fed Funds | Before 3 May FOMC meeting | ||||||
Target range | May | June | July | Sept | Nov | Dec | |
No hike | 0.75-1.00% | 96% | 29% | 26% | 17% | 17% | 11% |
1 hike | 1.00-1.25% | 4% | 68% | 63% | 51% | 49% | 37% |
2 hikes | 1.25-1.50% |
| 3% | 11% | 28% | 29% | 36% |
3 hikes | 1.50-1.75% |
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| 4% | 5% | 14% |
4 hikes | 1.75-2.00% |
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| 2% |
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| After 3 May FOMC meeting | |||||
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| June | July | Sept | Nov | Dec |
No hike | 0.75-1.00% |
| 26% | 24% | 13% | 13% | 8% |
1 hike | 1.00-1.25% |
| 74% | 69% | 49% | 48% | 35% |
2 hikes | 1.25-1.50% |
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| 7% | 35% | 35% | 40% |
3 hikes | 1.50-1.75% |
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| 3% | 4% | 15% |
4 hikes | 1.75-2.00% |
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| 2% |
Source: CME Fedwatch
“This is largely the result of a comment on the FOMC statement that: “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 first-quarter GDP growth number disappointed at just 0.7% on an annualised basis and that came on the back of poor retail sales numbers, a fourth straight year-on-year drop in auto sales and last month’s disappointing non-farm payrolls and wage growth figures.
“None of that reads well so it is interesting to see the Fed maintain confidence in the economic outlook. Yellen and her team are taking the view that the Q1 figure is an outlier and they may be encouraged to do so by recent history – as the Q1 figure was easily the lowest of the year in 2010, 2011, 2014 and 2016 as well.
| US annualised GDP growth rate | |||
| Q1 2010 | Q2 | Q3 | Q4 |
2010 | 1.7% | 3.9% | 2.7% | 2.5% |
2011 | -1.5% | 2.9% | 0.8% | 4.6% |
2012 | 2.7% | 1.9% | 0.5% | 0.1% |
2013 | 2.8% | 0.8% | 3.1% | 4.0% |
2014 | -1.2% | 4.0% | 5.0% | 2.3% |
2015 | 2.0% | 2.6% | 2.0% | 0.9% |
2016 | 0.8% | 1.4% | 3.5% | 2.1% |
2017 | 0.7% |
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Source: FRED, St. Louis Federal Reserve database
“The strong rebounds in Q2 in 2010, 2011 and 2014 suggest that the seasonal adjustments to the figures are creating some distortions, although if the Fed does tighten in June and again in the second half – to meet its target of three hikes this year –and growth does not pick-up then there would be risk that the Fed overdoes it and tightens policy too aggressively, choking off the economy.