As expected, the Fed hiked its fed funds rate by 25bp to 0.50-0.75%. But, unexpectedly, the anticipated number of rate hikes (median projection) was revised up from 2 to 3 hikes for 2017, sending a hawkish signal.
Is the hawkish signal the prelude of an acceleration in the pace of normalisation?
We doubt this, for several reasons:
Assimilating a period of reflation with a period of out-of-control inflation would be a mistake. It is true that both core and headline inflation have accelerated over the past 12 months. But these two metrics have remained at exceptionally low levels since the current cycle started (mid-2009). Average inflation over this period has fallen to its lowest level since the early 1960s. There is no genuine inflationary threat in the US even though inflation is likely to accelerate next year. We are a long way from an inflationary boom. True, the Fed needs to anchor inflation expectations by hiking rates but there is no need to move away from the gradual pace. This is all the more true since USD appreciation will exert disinflationary pressure
Fiscal policy is responsible for the Fed’s more “hawkish” stance
In other words, the Fed is likely to remain very cautious next year. We are sticking to our views and expect two rate hikes in our central scenario in 2017. However, should fiscal policy be more proactive than we expect, the Fed would no doubt support the reflationary trend by hiking its key interest rates throughout 2017, possibly even more than 3 times. But, at the end of the day, the rebalancing of the policy mix (tighter monetary policy, easier fiscal policy) is likely to have a small impact on growth on a two-year horizon.
Within inflation picking up again, Janet Yellen's speech before the Economic Club of New York on March 29 was highly anticipated. Ms. Yellen's accommodative stance was not a surprise: indeed, she delivered the same message afterthe FOMC on March 16. However, the Fed's “reaction function” was outlined a little more clearly.
Head of Macroeconomic Research
Didier BOROWSKI, Tristan PERRIER