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FOMC preview – doves turn into hawks

As the US economy continues to chug along, US policymakers need to start talking up the prospect of a faster pace of tightening.

Wednesday’s Federal Reserve (Fed) decision is something of a foregone conclusion. The Federal Open Market Committee (FOMC) is all but certain to raise interest rates. It would be a surprise if they did not, having been on a steady hiking policy for a year or more.

A quick overview of the situation reminds us that unemployment claims are at a 49-year low, new home sales remain on a steady upward trend and total US retail sales made a new all-time high in July. Not one of these three indicators suggests that the economic expansion, or its accompanying bull market, has come to an end. As a result, the Fed will be content to keep raising interest rates.

But what will be important to watch is the statement released with the decision and the press conference that goes with it. The Fed still needs to nudge up market expectations of a faster pace of tightening in coming years. At present the overall market is still sceptical that the Fed will increase the pace of its tightening. But that is the message that has been trumpeted of late by some of the FOMC’s previously most dovish members.

Lael Brainard is just such a dove. Traditionally she stuck to the view that the Fed should be as cautious as possible on rate hikes, in order not to derail the economic recovery. But now she has said that the neutral rate, at which gross domestic product (GDP) grows at its trend rate and inflation remains stable, is likely to be above the longer-term rate, indicating that more rate hikes are on their way.

This comes as the US economy and monetary policy continues its broad divergence away from other economies. While the European Central Bank (ECB) has declared it will end its quantitative easing (QE) policy in December, rate hikes remain a way off. The Bank of England (BoE) might have raised in August, but it seems content to sit on its hands for the foreseeable future. And despite a hawkish turn earlier in the year, the Bank of Japan (BoJ) is wedded to its loose monetary policy ways.

For the Fed, an expanding economy and higher interest rates will provide the headache of a rising US dollar. US President Donald Trump has previously criticised the central bank for this policy, but there seems little sign that this occasional thunderbolt will change matters. Instead, a rising dollar will potentially provide a headwind for some parts of the US economy, but a rising tide lifts all boats in the end, so there seems little reason to think that, either from an economic or monetary policy perspective, the great bull run in US stocks is under threat.

Federal Reserve meeting

Everything you need to know about the Federal Reserve’s FOMC announcement – including when it is, and why it’s important.

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