The Federal Reserve has raised rates four times in the cycle that began in December 2015 and just as monetary policy seemed slow to have an impact when it was being eased in the throes of the Great Financial Crisis, the removal of that accommodation has limited impact, explains the analysis team at BBH.
Key Quotes
“Financial conditions have become looser, according to various models, including the St. Louis Fed’s. By its calculation, as of the end of May financial conditions were at their easiest in three years. Simply put, outside of the short end of the yield curve, which is anchored by the Fed Funds target, interest rates are lower than they were when the Fed hiked in December 2016, let alone March 2017. Major US equity indices hit record highs in Q2.”
“At the same time, however, growth has disappointed, and price pressures have subsided. The Fed’s targeted measure, the deflator for personal consumption expenditures, excluding food and energy, drifted lower in the February through April period. The core measure of CPI has fallen for five months through May. This has left investors unconvinced that a September rate hike is particularly likely. The Fed funds market appears to be discounting about a 40% chance of such a move.”
“If the core PCE deflator does not firm in the coming months, not only will the odds of a Fed hike diminish, but it may also impact the Fed’s willingness to take the next step in the normalization process and let its balance sheet begin to shrink. On Bernanke’s watch, the Fed’s tapering strategy was devised; under Yellen’s, it was implemented. Similarly, under Yellen’s leadership, the shrinking of the balance sheet is likely to begin shortly after the September 20 FOMC meeting, leaving the potential third hike of 2017 for the end of the year.”
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