Schroders Quickview: Dollar strength tips Fed towards later rate rise

Federal Open Market Committee meeting triggers a change in rate hike forecasts, says Schroders Chief Economist & Strategist Keith Wade.

20 March 2015

Keith Wade

Keith Wade

Chief Economist & Strategist

The latest statement from the US Federal Reserve (Fed) had something for everyone, with both hawks and doves claiming it confirmed their views on the future path of rates. Although it remains a close call, we are pushing our forecast for the first US rate rise out from June to September 2015.

As expected, the Fed dropped its pledge to be "patient" before raising rates thus creating the opportunity to move for the first time in nearly a decade. Although this supports the view that the first rate rise will come in June, any hawkish sentiment was softened by a dovish assessment of the economy.

The Federal Open Market Committee cut its forecasts for growth, inflation and future interest rates. In short, the Fed sees more slack and less wage pressure than before, meaning that it can take its time in making its first move.

Rate hike bet too tight to mention

From our perspective the timing of the first rate hike is still a close call. The labour market will continue to tighten. Unemployment is set to drop significantly further. We expect activity to pick up after the recent soft patch, which owes much to the one-off effects of bad weather and the West coast dock strike.

Against this have been concerns about low headline inflation and the risk of contagion to the emerging markets from higher US rates. However, low headline CPI prints are a consequence of low energy prices (which we see as positive for the economy) and contagion risks are always with us and will only build if rates never rise.

Tightening monetary conditions

In our view, the factor tipping the balance toward a later move is the strengthening of the US dollar. Whilst a strong dollar has been part of our forecast we did not expect the scale of the move seen since the start of the year.

As a result monetary conditions have tightened by more than expected, putting downward pressure on activity. In particular, imported goods prices will be lower, thus weighing on core inflation and allowing the Fed more leeway on tightening.

We still believe that rates need to rise as the economy is getting back to normal with unemployment near equilibrium and credit growth resuming. However, the Fed is clearly happy to be cautious and keep the liquidity flowing for a little longer.

 

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