Fwd: US Fed policy: Monetary tightening resumes

[Rajesh Desai]

---------- Forwarded message ----------
From: <rese...@icicibank.com>
Date: Thu, Dec 15, 2016 at 2:38 AM
Subject: US Fed policy: Monetary tightening resumes
To: stock...@gmail.com

In line with our expectations, US Fed resumed its normalisation process and increased the Fed funds rate target range by 25 bps to 0.50%-0.75%. Fed’s forward guidance and Janet Yellen’s commentary remained broadly dovish, even as the dot plot indicated an increased pace of rate hikes in 2017. Incoming data continues to remain key. Markets went into a risk-off mode as the dot plot expectation of rate hikes in 2017 was revised from two to three. Fed hikes interest rate after a pause of one year In line with our expectations, the US Federal Reserve increased the Fed Funds rate target range by 25 bps to 0.50%-0.75%. The FOMC judged that in light of realized and expected labour market conditions, as well as the progress on the inflation front, it was deemed appropriate to hike the Fed Funds rate. The stance of monetary policy continued to remain accommodative. There were no dissenters. Fed assessment of economic activity, labour market and inflation The Fed noted the moderate pace of expansion in economic activity, while mentioning solid job gains and a decline in the unemployment rate. The Fed also cited an increase in inflation as well as market-based measures of inflation compensation. Inflation is expected to move to the 2% target in the medium term as transitory impact of declines in energy prices and non-energy import prices dissipate. Risks to the outlook were still judged as roughly balanced. In the Summary of Economic Projections (SEP) that accompanied the statement, the FOMC revised higher its projection for GDP growth for 2016 and 2017, while the unemployment rate projection was revised slightly lower for both years. The latter is line with the firm recovery seen in the labour market. As per our expectation, the FOMC revised its PCE inflation projection upwards for 2016, while core inflation expectations were unchanged. Chart 1: Pace of normalisation expected to be more rapid, but to remain contingent on incoming data Source: US Federal Reserve Pace of normalisation to be faster than envisaged in September The median Fed Funds rate projection for 2017 was revised higher to 1.375% (prior 1.125%), while the same for 2018 was raised to 2.125% (prior: 1.875%). The terminal rate was revised upwards to 3.0% from 2.9%. The current dot plot indicates a faster pace of rate hikes in 2017 (3 hikes), as compared to the expectation from the September dot plot (2 hikes). Fed Chair, Janet Yellen, mentioned in the accompanying press conference that the broad upward shift in the dot plot may have resulted from participants incorporating fiscal expectations in their Fed Funds rate projections, while emphasizing that the upward revision was a minor change. The policy statement highlighted that in determining the timing and size of future adjustments to the target range for the Federal Funds rate, the Committee would assess realized and expected economic conditions relative to its objectives of maximum employment and 2% inflation. Incoming data on a range of parameters spanning “labour market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments” will remain key in guiding policy. Chart 2: SEP broadly unchanged Source: US Federal Reserve Implementation note details normalisation tools The implementation note released along with the policy statement provided clarity on operational settings of the Federal Reserve's policy tools (used to facilitate the normalisation process). FOMC participants voted to raise the interest rate paid on required and excess reserve balances (IOER) to 0.75% (prior: 0.50%).  The FOMC authorised the use of overnight reverse repurchase facility (ON RRP) and set the offering rate at 0.50%. Further, the discount rate (primary credit rate) was raised by 0.25 percentage points to 1.25%. (See Appendix for details). The Committee will continue its policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities and of rolling over maturing Treasury securities at auction; thereby aiding in maintaining accommodative financial conditions. Markets on a risk off mode Even though the rate hike was broadly in line with expectation, market went into a risk off mode as dot plot expectation of rate hike in 2017 was revised from two to three. In essence the Fed commentary was more hawkish than anticipated by the markets. In the fixed income market, while both the two year as well as the ten year US Treasury sold off, the pressure was greater on the two year bonds. In the currency market both Euro and Japanese Yen sold off vis-à-vis the Dollar. Dollar index gained, adding to the appreciation bias since Trump’s election on November 8th. The Dollar’s gain added to pressure on crude and gold prices and weighed on emerging market assets. Policy normalisation to be slow and calibrated Given the resumption of the normalisation process, future policy moves are likely to be dependent on incoming data prints, which will remain critical. Any expansionary fiscal stimulus from the incoming regime at the White House may spur inflation, and cause a faster pace of rate hikes than anticipated.  Ms. Yellen emphasized that considerable economic uncertainty persists amid unknowns such as fiscal policy, crude oil prices and global economic and financial developments, among others. Focus is now likely to shift to third print for GDP growth in Q3 2016 (due on 22nd December), as well as CPI inflation readings (due today). Going ahead, new policy announcements made by the incoming administration, once it takes office on 20th January, 2017, will remain in focus. Regards, ICICI Bank Contact: Samir Tripathi (+91-22) 2653-7233 samir.t...@icicibank.com Sumedha Dasgupta (+91-22) 2653-1414 (extn: 7243) sumedha....@icicibank.com ​

--

CA. Rajesh Desai