Group Economics
US Watch
Macro & Financial Markets Research Maritza Cabezas, +31 20 343 5618
Fed preparing for lift-off
13 August 2015 We expect the Fed to raise interest rates in September. GDP is growing above trend and we are seeing further improvement in the employment situation. In our view, the Fed will maintain a 25bp target range for the Fed funds rate, which implies that the first move will shift the target range to 25-50bp, ending at 50bp-75bp at the end of 2015 and 150bp-175bp at the end of 2016. All together this means one rate hike every other meeting in 2015 and 2016. The slow pace of rate hikes takes into consideration the somewhat tighter financial conditions, resulting from the strong dollar, given that the Fed is far ahead of other central banks. In line with this view our EUR/USD forecast for the end of 2015 remains 1.00. Introduction
Past and Present Tightening cycles in US economy %
Fed policymakers are giving signals that they are getting ready to hike rates this year. The US economy looks strong enough
8
to handle a rate hike. In this note we address how the Fed is
5.7
preparing for the rate hike, the path for interest rate normalisation and the instruments that the Fed could use in
5.4
4.2 4 2.3
2.2 1.3
this process. 0
Economy ready for a rate hike
GDP growth
unemployment
core PCE
This time around, the economy may not be as resilient but the 1 yr before
fundamental factors underlying US economic activity are solid
Now
and, in time, should lead to a pick-up in the pace of economic activity and inflation. Recently Fed policymakers have
Source: Thomson Reuters Datastream
mentioned that the economy would need to show “some” improvement before a rate hike. Since then statements from
Labour market conditions firm, wages subdued
Fed officials suggest that the economy is moving in the right
Unemployment has declined significantly during the recovery.
direction. For instance, Dennis Lockhart, President of the
Moreover, job openings and quits have been steadily
Federal Reserve Bank of Atlanta said in an interview with the
improving in the past year. However, wage growth remains
Wall Street Journal that a Fed rate hike is ‘close’, noting that
subdued. We think that slower productivity growth could be
he is open for a September move. Meanwhile, the President of
keeping wages supressed, since higher wages in a context of
the Fed St. Louis, James Bullard (voting in 2016) told the WSJ
lower productivity reduce profit margins. However, this should
late in July that “we are in good shape” for a rate hike in
not be an impediment to a rate hike. Fed Chair Yellen has
September. In this same line, President John Williams of the
repeatedly stated that higher wage growth is not a necessary
Federal Reserve Bank of San Francisco also reiterated his
condition for a rate hike.
forecast for a rate liftoff this year. In time, inflation should move towards the target GDP growth, lower but above trend
Inflation may look distant from the Fed’s 2% goal, but this is a
Long trend GDP growth has slipped somewhat since the global
medium-term objective. We expect that inflation will remain
financial crisis. Indeed, average trend growth was around
below 1% this year, but will move towards the 2% target next
3.1%, but the global financial crisis took its toll with a loss in
year. The strong economy should see slack dissipate, which
output and potential growth now around 2%. This suggests
should push up inflation. In addition, rising rent prices and the
that although US economic growth is lower than in previous
reduced pass-through from the stronger dollar should also lead
cycles, it is currently growing at above-trend rates. As a result,
to price increases in the coming months. Fed officials have
slack is diminishing and this is likely one of the major reasons
persistently signalled that they expect some of the factors that
the Fed will hike .
are exerting pressure on prices to wane.