US: Monetary policy outlook still no clearer - ING

The outlook for US monetary policy is uncertain with the market continuing to doubt the Federal Reserve’s projection for interest rates which will persist until inflation starts to rise, irrespective of the growth story, according to James Knightley, Chief International Economist at ING.

Key Quotes

“Fed funds futures continue to barely price in one interest rate rise over the next 18 months versus the Fed’s June FOMC projections of four 25bp hikes. We remain somewhere in the middle, predicting a rate rise in December and then two more next year. This is based on the belief that inflation will respond to the tightness in the labour market, strength in economic activity reducing the output gap and, at the margin, the 10% fall in the dollar pushing up import costs. Indeed, we are starting to see producer price inflation pick up and believe it is only a matter of time before consumer-based measures of inflation respond.”

“This is not going to happen today with the personal consumer expenditure deflator set to remain well adrift of the Federal Reserve’s 2% target. In fact there is the risk that the readings drift lower to 1.3% YoY. As such, markets will remain unconvinced on the rate hike story irrespective of what is happening to activity.”

“On that front, the news hasn’t been too bad with last Friday’s GDP report showing the economy expanded at a 2.6% annualised rate while the ISM indices are at levels historically consistent with GDP growth of 4-6% and consumer confidence is close to cycle highs. We see a risk of a slight pull back in today’s manufacturing index given the surveys appear to have overshot activity to some extent while regional surveys have softened a touch. Nonetheless, the index is likely to stay at strong levels with the employment component closely followed for implications for Friday’s jobs report. That said, even if we get a rise in the index, it is likely to be ignored by a market focused on the lack of inflation threat.”