Fed look ahead

Another rise in US interest rates seems almost certain, as Janet Yellen and co boost the cost of borrowing to 1.25%. This is so widely expected that likely the rate increase itself will do little for the US dollar. The greenback has already rallied slightly, albeit within the context of a steady downtrend since the December high.

Instead, attention should focus on the committee’s outlook for the rest of the year. The Federal Reserve (Fed) said that it planned to hike three times this year. A move in June means that two of those moves have already been made, which would mean that either September or December will bring meetings when no policy change will take place (these meetings have press conferences attached, and conventional thinking argues that the Federal Open Market Committee (FOMC) only moves when it has a press conference at which it can explain itself).

Unless, of course, the Fed talks up the chances of four rate increases in 2017. Such a move would provide a real boost for the US dollar, representing an increase in the pace of tightening in the US, although the Fed will probably continue to argue it is still a ‘gradual’ pace. Such a discussion would take place within the context of the strength or otherwise of US economic data. In May the committee noted how Q1 had seen a weakening, but it viewed it as a transitory period and no cause for alarm. If the Fed becomes more optimistic about the outlook it would start to think more seriously about shifting up a gear where rate hikes are concerned.

The other thing to watch out for is further discussion of the unwinding of its QE balance sheet. This was first mooted earlier in the year, and is arguably far more significant. Even now, with QE officially finished, the Fed has to keep purchasing bonds as it reinvests the proceeds, keeping policy fundamentally loose. When it stops reinvesting the proceeds and begins reducing the size of its balance sheet, we may see a rather different outlook for markets. Still, for now the Fed is treading very carefully around this point, and will continue to do so for a while yet.