Fed: Summer rate hike more likely than it previously believed - BBH

Research Team at BBH, notes that the Federal Reserve succeeded in convincing the market that a summer rate hike was more likely than it previously believed.

Key Quotes

“Moreover, Dudley, who we argue is part of the Fed’s leadership from which policy emanates, recognized risks posed by the UK referendum, and put the market on notice that although there is no scheduled press conference afterward, a move at the July meeting is also a distinct possibility.

Although the Federal Reserve has indicated that two rate hikes are likely this year (rather than four that it envisaged late December), investors have been skeptical (and more skeptical than economists). Some critics cited this as evidence of the Fed’s loss of credibility. One need not accept the Fed is a slave to the markets, as other critics claim, to appreciate that the gap between the market and the FOMC posed an operational challenge. Under such conditions, the rate hike could be more disruptive than necessary.

Last week, the Fed regained the upper hand. In the first part of the year, there was often a 100 bp spread between the FOMC’s dot plot and the Fed funds futures strip. The March dot plots in effect cut the gap in half. And now the combination of the recognition that rather than a recession, the US economy is reaccelerating, and the Federal Reserve is committed to opportunistically and gradually normalizing US monetary policy, is prodding investors to move closer to the Fed’s position.

In addition to the reassertion of the Federal Reserve’s credibility, another implication of the increased likelihood of a rate hike is that it casts doubt on the talk of a secret agreement at the Shanghai G20 meeting in late-February. The delay between the first Fed hike and the second one was not a function of some agreement among the G20 to weaken the dollar.

The delay was the result of the Fed’s assessment of domestic and global economic considerations. As those considerations changed (US economy strengthening, global markets stabilized), the Fed is preparing the markets for a resumption of hiking cycle. The heightened realization that the Fed is not “one and done” like some many have claimed may have knock-on effects on equities, emerging markets and commodities.”