Fed Monitor: Forward guidance linked to inflation outcomes and faster QE buying on the cards
|Key takeaways
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The Fed has changed its reaction function in two important ways. 1) It will no longer tighten monetary policy just because unemployment is low if wage and inflation pressure is subdued and 2) The Fed will tolerate inflation above 2% without tightening monetary policy.
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Fed call. We expect the Federal Reserve to change its forward guidance stating that the Fed funds target range will not be lifted 'until inflation will run above 2% for some time'. We also think the statement will include more references to inflation expectations. We expect QE buying to be linked to inflation as well and think a faster buying pace is on the cards (although it is not a high conviction call).
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Risk. Actions speak louder than words and unfortunately we see a risk that the Federal Reserve does not deliver that much at the upcoming meeting. If so the Federal Reserve may join the club of central banks with '0% rates and QE buying forever' if it fails in building up credibility right away. This is also why easing more is necessary at the upcoming meeting.
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FX. On balance, the Fed's policy combined with (our expectations of) global macro means EUR/USD is likely to trade in the 1.18-1.20 range with risks tilted to the upside, especially on a 3M horizon. See details on page 4.
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Equities. No matter how the Fed intends to implement the policy shift it means that monetary policy will be more important for equities near-term. Details on page 5.
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Fixed income. We argue that 10Y US real rates are next to move higher, and that the real-rate gap will be slightly less negative. In our view it will mainly be US nominal yields that will move higher. Details on pages 5-6.
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