19th March 2015
Anna Stupnytska, global economist at Fidelity Worldwide Investment, looks at the latest rhetoric coming from the US Federal Reserve…
While ‘patient’ was dropped at the March FOMC meeting as widely anticipated, the Fed’s statement and press conference were clearly on the dovish side. For me, two important messages stood out.
Firstly, the Fed explicitly acknowledged the effects of a stronger dollar on growth and inflation, implying that all the positive forces driving the economy, including a potential boost to consumption coming from lower energy prices, are perhaps not going to be sufficient to offset the negative dollar drag at this point and beyond, had the dollar rally continued.
The second interesting change was a downward revision to the long-term unemployment rate projection (a proxy for NAIRU) to 5.0-5.2%, implying labour market slack remains. This in turn means that inflation and wage growth—and hence rates—can stay lower for longer.
With the Fed’s emphasis on data dependency, from now on investors should focus squarely on just that—the data. It seems the Fed continues to believe that costs of hiking too early and too fast are clearly higher than costs of being behind the curve and moving slower—and I concur with this view. For this reason, the Fed will not move until they—and the markets—are absolutely sure.
In this respect, three indicators are key to watch: (1) unemployment and its broader measures; (2) wage growth; (3) core inflation. Only a definitive turnaround in these will give the Fed confidence to move ahead with the first hike but even then there will be no rush to keep tightening. All in all, I stick to my view that a June hike is highly unlikely. I still believe rates will rise later this year, perhaps September, with risks now heavily skewed towards a later date.
As for market implications, the Fed clearly made a big effort to avoid the repeat of the taper tantrum seen in 2013, presumably taking on board the numerous warnings concerning potential market instability, particularly in emerging market assets. So with the Fed blinking and other central banks in the full easing mode, it is risk on for the markets: higher equities, higher fixed income, lower USD, at least for now.