Market euphoria has eased as traders digest the federal Reserve’s rate hike sentiment. While four rate hikes for 2017 has not been dispelled by Fed member Dudley, the dollar is behaving as if Yellen and her colleagues slashed the cost of borrowing. The greenback decreased 2% last quarter. Diverging its attention from rate hikes, the greenback is instead focusing on the infamous ‘’dot plot’’, the rate and place at which the Fed anticipate rate increases, which barely budged in the last meeting.
Traders predicted a hawkish fed, and were served a mildly dovish sentiment.
Were the fed wrong not to change their interest rate forecast? Probably not.
The Fed is notoriously bad at predicting the course of inflation. Over the past few years, they have over-estimated medium-term inflation and now, they are favouring a more conservative view.
The core PCE inflation rate still lags behind the target rate of 2% at 1.7%. This is a key indicator for the Fed and is treated with precision. If this rate is not reached, the Fed will have a dovish rhetoric.
Furthermore, US counterparts in both Europe and Asia are experiencing mild inflation and although president Draghi has started to tapper the amount of bond-purchasing the ECB does, Europe still has a way to go before increasing interest rates. Similarly, Japan has just started to master deflation that reined over the region for many years. Going against the tide and raising interest rates is risky and the Fed are entering uncharted waters.
Not to forget the large question mark that lies over fiscal stimulus from the Trump administration. Without details on things like tax reform, infrastructure and the possibility tariffs, it’s hard to gauge just how much market stimulus will derive from Washington.
Now for the labour slack in the US economy. There is a lot of dispute over the unemployment rate. The official rate is at 4.7%, however, the labour participation rate is skewed. The labour force participation rate still remains somewhat depressed, with able individuals still remaining outside of the workforce.
Here’s where the Trump administration could really make a difference as Fiscal policy cannot be ignored in the battle to increase labour participation. Policy makers need to focus on healthcare policy and childcare subsidies, which at present, are huge barriers to entering the labour force in the U.S. Trump’s plan for healthcare reform is a huge unknown for the federal reserve who will need comprehensive details before pricing in the effects of such a monumental change to the economy.
Tying in with this, is productivity growth, the most important economic driver, which is still lagging. The labour productivity data has a direct relationship with the wealth of its nation. As the figure extends, so too does the standard of living. Given the aging population, the US must see a sharp rise in productivity to see the standard of living increase. For example, by an injection of educational resources.
Finally, US GDP outlook is not as positive as when president Trump was just president-elect Trump. Since the president has moved into the white house, forecasts have inched downwards now at 2.8% for 2018, down from 3%.
There are many uncertainties the Fed needs to clarify before nudging up forecasts, I think the dollar is starting to notice those uncertainties too.
However, the real fun starts when the Fed start to off-load their 4.5 trillion-dollar balance sheet, which will probably be tackled by a Trump-appointed Federal Reserve Chair.