Fed keeps forward guidance but revises projections higher yet again

As it turned out, the Fed hung on to its forward guidance of “considerable time” in the statement but the projections turned markedly higher, giving the Fed meeting another hawkish turn as expected.

In the statement there was a slight dovish twist as inflation was again described as running below the longer-run objective, whereas before it was said that it moved closer to the objective.

In terms of labour market slack the FOMC still sees significant underutilisation of labour resources.

The projection for the Fed funds rate at the end of 2015 was raised to 1.375, which will actually require four rate hikes (assuming they move to 0.5% in the first hike). This would fit well with our expectation that they start in April and then hike again in June, September and December.

The projection in 2016 was moved higher again (has been revised higher at every new projection since December). At the end of 2016 the FOMC median projection is 2.875% up from 2.5%. This is markedly higher than current market pricing at 1.85%. It must be a bit of a worry that the market has basically not changed its pricing this year, while the Fed has consistently moved its projection higher. The end-2017 projection shows a median projection of 3.75%. That's at least 100bp higher than market pricing.

Richard Fisher joined Charles Plosser in dissenting to the statement as they object to the time based forward guidance.

At the press conference Janet Yellen downplayed the guidance as being calendar based and emphasised that it was linked to developments in the economy. It seems likely though that the forward guidance will go at the next meeting in October. The Fed may have refrained from removing it at this meeting to not seem too hawkish given the big change in projections.

In terms of market views, we continue to look for increases in short end yields sooner or later and a further bearish flattening of the yield curve. We also look for further USD strength as the repricing takes place.

Why are money market rates stubbornly low given the Fed projections? One explanation could be that managers of short end funds or organisations that place money in liquid assets with short duration the US rates seem attractive relative to the negative rates seen in the euro area. Hence, the extreme low rates in the euro area may cause distortions in short end pricing of the US. Sooner or later, the short end rates have to reflect the reality, though, and a repricing will likely take place closer to the first hike.