As was almost unanimously expected by market participants, the Fed left its key interest rate target range unchanged yesterday evening at 1.5% to 1.75%. The accompanying statement on the interest rate decision, from which information on the course of monetary policy going forward can be obtained, was only slightly adjusted from the version released after the previous meeting in March. A number of market participants had anticipated that the central bank would significantly sharpen the wording of this statement to highlight inflationary threats, particularly in view of the healthy development of the US economy and the recent rise in the PCE deflator – the Fed’s preferred measure of inflation. No such adjustment was made, however. Indeed, the monetary policy communique released yesterday provided virtually no fresh clues whatsoever regarding a possible hike in key rates next month. Although the Fed did acknowledge that household spending had moderated in the first quarter of the year (compared to the fourth quarter of 2017), it also underlined the fact that business investment had continued to increase strongly. The medium-term risks to the economic outlook were therefore considered to be roughly balanced. The guardians of US monetary policy also observed that inflation had risen and was now coming into line with the official inflation target. In the medium term, annual inflation is expected to remain close to the Fed’s symmetrical inflation target. The interest rate decision by the FOMC was unanimous.
The reaction of market participants to the Fed’s decision was muted. Yields on 10-year US Treasuries initially responded by declining slightly. The probability of a rate hike in June continues to be almost 100%.
One striking aspect in the Fed’s latest statement was the deletion of two passages. This included the removal of the observation that there had been a recent acceleration in economic momentum, and deletion of the statement that the Fed was observing the development of inflation very closely. This would suggest that FOMC members are at ease with the latest rise in the rate of inflation. The guardians of monetary policy do not appear to be too concerned about a strong rise in inflation, as was also implied by the additional observation that the inflation target is symmetric. This can be interpreted as meaning that inflation could even rise above the target of 2% without the Fed feeling the need to slam on the monetary brakes. In other words, the Fed has not fuelled expectations – as held by a number of market participants – that monetary policy is set to be tightened significantly. At the same time, the statement contained nothing specific in respect of a further hike in key rates in June. We nonetheless continue to anticipate a rate hike of 25 basis points next month. In addition, we continue to expect the Fed to adhere to its policy of gradually increasing interest rates as the year progresses.