The June FOMC meeting was anticipated by Westpac to deliver another 25bp increase in the Fed Funds Rate and to also confirm that the Committee expects to begin the process of balance sheet normalisation during 2017 and on both fronts, these expectations were met, explains the research team at Westpac.

Key Quotes

“On the Fed Funds Rate, this is the second of three hikes anticipated by the FOMC and Westpac in 2017, taking its range to 1.00%-1.25%.”

“The Committee’s Fed Funds’ expectations for end-2017 and beyond were broadly unchanged at the June meeting. Following a third hike in 2017, three more rate increases are anticipated in 2018, to be followed by another three in 2019. That would take the Fed Funds Rate to 2.9% at end-2019, which is broadly in line with the Committee’s 3.0% ‘longer run’ expectation. (Note that the range of forecasts provided by Committee members narrowed incrementally in June, at both the lower and upper bound.)”

“In considering the risks to the interest rate outlook, it is important to recognise that Chair Yellen continues to believe that the Fed Funds Rate is only marginally below its current neutral level. With inflation of 1.6%yr anticipated in 2017, a real neutral rate of zero would be achieved after two more hikes (March 2018).”

“While stopping short of announcing a start date for the run-off, in the press conference Chair Yellen noted that, should conditions remain conducive, the implementation of their balance sheet plan could come “relatively soon”. She also noted that no decision had been made as to whether it was (or was not) appropriate to start normalisation at the same time as 2017’s third rate hike is announced. At this stage, we favour the third hike coming in September and normalisation beginning in the December quarter.”

“Still, it is clear that the normalisation process will take place over a number of years (at least four), and result in the balance sheet being reduced by more than $2trn. At this stage, we have no reason to differ in opinion from the FOMC over the pace and scale of normalisation; their view is in line with our expectations.”

“The final piece of the puzzle regarding the outlook for the economy is the market’s expectations. Coming on the back of disappointing retail sales data for May (due to weak auto sales, retail sales fell 0.3% in May, its weakest outcome since January 2016; further, core sales were flat in the month, though April was revised up to 0.6%) and more importantly soft CPI inflation (headline prices falling 0.1% in the month and annual core inflation below target at 1.7%yr), post-FOMC the market does not have another Fed Funds hike priced till late-2018. Further, the 10yr Treasury yield ended the session down at 2.13%, the lowest level it has seen since before President Trump’s election. Clearly the market consensus is that there are material downside risks to the FOMC’s view on policy and arguably to the broader economy.”

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