On Wednesday, June 14, the U.S. Federal Reserve decided to raise the benchmark interest rate to 1.25%, as expected by the market. The decision was made with 8 votes in favor and 1 against. Neil Kashkari opposed the regulator’s decision.
Unexpected Optimism from the Fed Supports Dollar Strength
Despite poor economic data for the U.S. in May, Fed officials noted that the expected pace of benchmark interest rate increases in 2017 and 2018 remained unchanged compared to March forecasts. In fact, this is what the market wanted to hear after the regulator’s meeting.
- 2017: 1.4% (unchanged);
- 2018: 2.1% (unchanged);
- 2019: 2.9% (down from 3.0% in March);
- Long-term: 3.0% (unchanged).
U.S. GDP forecast improved:
- 2017: 2.2% (up from 2.1% in March);
- 2018: 2.1% (unchanged);
- 2019: 1.9% (unchanged);
- Long-term: 1.8% (unchanged).
Consumer Price Index (CPI) forecast:
- 2017: 1.6% (down from 1.9% in March);
- 2018: 2.0% (unchanged);
- 2019: 2.0% (unchanged);
- Long-term: 2.0% (unchanged).
Core CPI forecast:
- 2017: 1.7% (down from 1.9% in March);
- 2018: 2.0% (unchanged);
- 2019: 2.0% (unchanged).
Unemployment rate forecast:
- 2017: 4.3% (down from 4.5% in March);
- 2018: 4.2% (down from 4.5% in March);
- 2019: 4.2% (down from 4.5% in March);
- Long-term: 4.6% (down from 4.7% in March).
Thus, expectations for rate hikes were slightly reduced for 2019, inflation forecasts were revised downward for 2017, GDP expectations were revised upward for 2017, and a more significant decline in unemployment is expected. Otherwise, the forecasts remained the same.
Despite the slowing price growth, the Fed predicts the same pace of interest rate increases. This is a new reality for the market, which previously believed that most regulatory decisions depended on the inflation level and its proximity to the target of 2%.
The accompanying statement notes that short-term risks for the economy are balanced, long-term inflation expectations remain at nearly the same levels. It mentions a decrease in inflation and that it will remain below the target in the short term.
Regarding the labor market, it was noted that the pace of improvement has slowed, but there is still strong growth since the start of the year. Other positive factors include increased household spending growth and increased investment in fixed capital.
Reducing the Balance Sheet in 2017
The U.S. Federal Reserve also announced that it will reduce its balance sheet in 2017, but no specific date was given. It will happen gradually and predictably. The plan is to reduce the asset volume below the levels seen in recent years, but higher than the levels on the Fed’s balance sheet before the 2008 crisis.
The EUR/USD pair reacted with a decline following the regulator’s meeting. Weak U.S. economic data published several hours earlier no longer had a determining effect. The main point is that the Fed remains committed to tightening monetary policy, even with weaker inflation data.
Janet Yellen’s statement clarified everything. According to her, the decline in inflation is due to temporary factors and there is no cause for concern.
U.S. dollar quotes fully recovered from the drop that occurred at 15:30 MSK and returned to the 1.12 level against the euro.
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FAQ
What was the Fed’s decision on interest rates?
The Fed raised the benchmark interest rate to 1.25% as expected by the market.
Did the Fed change its inflation forecast?
The Fed revised its inflation forecast downward for 2017, but kept other years unchanged.
How did the dollar react to the Fed’s decision?
The dollar strengthened after the Fed’s decision, recovering from earlier declines.
