FOMC minutes: Fairly soon = March or June?

The most recent FOMC minutes suggest to us that March is a live meeting for the next US interest increase, in contrast to market expectations which imply a less than 20% probability of a hike. We believe the market continues to underestimate the resolve of the US Federal Reserve to use the opportunity of low unemployment and close to target inflation to re-normalize US interest rates. On the direction of interest rate policy the minutes were relatively clear with merely in-line incoming data sufficient to warrant a rate increase, consistent with Fed Chair Yellen’s recent public comments. However, on balance the timing indication of ‘fairly soon’ seems to imply a hike somewhat sooner than mid-year: “…many participants expressed the view that it might be appropriate to raise the federal funds rate again fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations…” We note also increased concerns within the Fed in terms of asset prices, with staff taking account of an increase in asset valuation pressures since November in their assessment of financial stability. There also seems to be some concern from meeting participants that the recent rise in equity prices may reflect an anticipated boost to earnings from a cut in corporate taxes or a more expansive fiscal policy which may not materialise. A ‘few’ FOMC participants also noted that the low level of volatility in equity markets appeared inconsistent with considerable US policy uncertainty. It seems to us that US equity prices may be reaching levels which are creating a degree of discomfort at the FOMC. This would add weight to Yellen’s previous views that it would be preferable to raise rates earlier and more gradually rather than later and abruptly. In terms of the Fed’s balance sheet, the FOMC Committee currently anticipates maintaining the reinvestment of principal payments from its mortgage and US Treasury portfolio “until normalisation of the level of the federal funds rate is well underway”. This therefore remains some way off but may become more of a focus for markets towards the end of 2017.

Fed fund futures remain well below Fed dot-plot expectations

Fed funds futures remain well below the Fed’s interest rate expectations as set out in its December statement of economic projections, Exhibit 1. Perhaps the best reason for the Fed not to raise rates in March is that it would surprise the market, something that has been seen as undesirable in the past. However, we continue to believe investors risk being surprised by an increasingly hawkish Fed over the course of 2017.