Economists expect the US Federal Reserve to leave benchmark interest rates unchanged when policymakers meet this month and next, but believe the uncertain outlook for global growth will not stand in the way of the central bank resuming its path towards normalisation in June.
Ahead of the Fed meeting this week, a large majority of the 53 top economists surveyed by the Financial Times said the US central bank would remain on hold until June, as sharp market gyrations and concerns over economic activity at the year’s start stay its hand.
But they saw slight flickers of inflation and a labour market that had created more than 12m jobs over the past five years ultimately coaxing the Fed back into action — albeit gradually — intensifying the divergence between monetary policy in Europe and Asia.
“The economy is looking better, inflation will pick up and that’s good on the dual mandate side,” said Ward McCarthy, an economist with Jefferies. “Consider the reaction to the European Central Bank. [The Fed] wants a little more time to let the dust settle, but all the necessary pieces are falling into place for a June hike.”
The rebound in US equity markets has soothed investor nerves, with the benchmark S&P 500 stock index now about 1 per cent below where it started the year. Equities had tumbled as much as 11 per cent at their nadir as crude prices slid, fanning fears that the US was on the verge of a recession.
The market rally has for the time alleviated a key hurdle for policymakers as they ready their message for Wednesday: companies have regained access to capital markets and financial conditions have eased.
A stabilisation in the price of oil and other commodities is expected to diminish a drag on inflation, a factor policymakers at the Fed have considered transitory. Less than half of the economists surveyed said that prices would run above the Fed’s 2 per cent target at some point over the next year.
Several more said inflation in the US would move above that level later in 2017.
However, the pace of tightening will be even more gradual than policymakers indicated in December, when they last released economic growth and interest rate projections. More than four-fifths of economists polled by the Financial Times said the Fed would lift rates two times or fewer this year. One believed the Fed would be forced to cut rates by December.
Policymakers have struck an increasingly cautious tone amid the market turbulence and lacklustre economic reports in the first two months of 2016. Bill Dudley, president of the New York Federal Reserve, warned earlier this month that the risks to his outlook had started to “tilt slightly to the downside”.
Lael Brainard, a member of the Fed’s board of governors, has been even more explicit. Last week, Ms Brainard told a conference that policymakers should be patient.
“Given weak and decelerating foreign demand, it is critical to carefully protect and preserve the progress we have made here at home through prudent adjustments to the policy path,” she said. “Tighter financial conditions and softer inflation expectations may pose risks to the downside for inflation and domestic activity.”
Economists expected the Fed to lower its projections for how fast it will raise rates over the next several years, although the survey found that the cohort continued to place greater faith in the central bank’s previous guidance than the market. Fed funds futures imply that the Fed will increase rates only once in 2016.
Market measures of inflation remain muted while incoming data have painted a picture that is at times contradictory.
The Fed’s preferred measure of inflation, the core personal consumption expenditures index, ticked up to 1.7 per cent in January. Separate data showed wages slipped in February, a closely scrutinised figure that underlies inflation.
Easing monetary policy in Europe and Asia may also slow the Fed, although ECB president Mario Draghi’s comment that he does “not anticipate” lowering interest rates deeper into negative territory provided a brief fillip for the euro.
That divergence, which fuelled fund flows until recently, has buoyed the US dollar and made exports from the country more expensive, in effect damping economic growth.
“It should mean less pressure to tighten,” Thomas Julien, an economist with Natixis, said. “It’s putting more pressure on the dollar and doing part of the Fed’s job.”