FOMC Meeting: What To Expect

US Treasury yields closed higher last week as the safe haven bid receded in the face of calming political turmoil in the Eurozone and a stronger than expected ISM Non-Manufacturing report in the US. Also, hawkish signals out of the ECB, boosted the case for higher yields in the Eurozone which provided a global backdrop of rising yields for the US treasuries. Yields on 2yr, 5yr, 10yr and 30yr UST closed the week at 2.50% (+2bps, w/w), 2.78% (+3bps, w/w), 2.95% (+5bps, w/w) and 3.09% (+4bps, w/w) respectively.

FOMC Meeting

This week will see the Federal Reserve hold its FOMC meeting followed by a press conference. Despite the recent increase in global turbulence from trade talks, the FOMC is widely expected to raise rates by another 25 basis points, lifting the target fed funds range to 1.75%-2.00%. With the rate hike almost 100% priced-in, investors will more closely watch for any change in the Fed’s dot plot or change of language in its press release.

No Change Expected In the Median Dot Plot

We expect no shift in the median year-end fed funds estimate for 2018, although the upside risk is high.

In March, six participants favored three hikes in 2018 and six participants favored four hikes. Since March, economic growth has surprised on the upside with the unemployment rate moving down faster than expected, and inflation rising close to the Fed’s 2% target. On the other hand, The World Bank recently revised its forecast for the global growth downwards, the dollar has strengthened over 4% against its major trading partners, financial conditions have become somewhat less accommodative with yields shifting upwards, and global risks (Iran sanctions, falling EM currencies, heightened concern over a trade war etc) have increased. Amid these counter-balancing forces, we expect Fed officials to keep their view unchanged on the number of rates hikes appropriate in 2018.  That said, the median for 2018 will shift up even if just one participant switches from preferring three hikes to four hikes this year. This is clearly the risk, however, the risk is largely already priced in with futures-implied probability of total rate hikes in 2018 already at above three.

No Material Change Expected In the FOMC Statement

We do not anticipate meaningful changes to the FOMC statement at this time. The Fed did not show much concern about the softer data in Q1 and, similarly, we do not expect much exuberance now even though activity has reaccelerated sharply in Q2. Most FOMC members probably still consider policy to be accommodative. With the economic growth steaming ahead and target fed funds rate still well below the long term neutral level of around 2.5%, we expect, the Fed to indicate high degree of comfort in continued gradual policy normalization.

Target Fed Funds Rate vs the Core PCE YoY%

Source: Bloomberg,Emirates NBD Research