Main takeaways
As the real economy is in good shape, the Fed is on autopilot until the target range reaches 2.75-3.00% (most FOMC members' estimate of the neutral rate)
After neutral is reached, it is more 'stop and go' depending on how the economy is doing and how markets are reacting to the monetary tightening. We expect the Fed to continue hiking next year.
We continue to see modest upward pressure for 10Y US treasury yields and have a 12M forecast at 3.25%.
Continued Fed hikes should help EUR/USD revisit the 1.15 area again during the course of the autumn.
Fed outlook: Fed on autopilot at least until March
In line with everyone else, we expect the Fed to raise the target range by 25bp to 2.00-2.25% at next week's meeting. We do not expect it to be necessary for the Fed to send any new important signals to the markets. We believe the most important parts of the statement will remain unchanged and even if the sentence 'monetary policy is accommodative' is removed or changed, it should not matter much, in our view, as it would just reflect reality.
With respect to the dots, the Fed will most likely still signal another hike in December (and probably that more FOMC members support this) and three hikes next year (it was divided between two or three additional hikes next year and it would take four members to move it higher). The Fed will also still signal that it is going to raise the Fed funds rate above the longer-run dot. The longer-run dot may be revised higher to 3.00%.
Currently, most FOMC members are signalling that the (nominal) natural rate of interest (the rate where monetary policy is neither expansionary nor contractionary) is around 2.75-3.00% and many, even the more dovish members, have signalled in speeches that the Fed is on autopilot until neutral is reached. That means that the hikes in December and in March seem very likely. Another hike during the summer next year, perhaps June, is also likely. The real economy is in good shape and is stronger than when the Fed started its tightening cycle : Growth is strong, employment continues to rise, wage growth is increasing, PCE core inflation is 2% and optimism is high. The trade war has not had a material impact on the US economy so far, partly because the US economy is quite closed and partly because the massive fiscal boost is offsetting the negative impact from trade.
After the Fed funds rate reaches neutral, it is more 'stop and go' depending on how the economy is doing and how markets are reacting to monetary tightening. At the June meeting, Fed Chair Powell hinted that the reason why the Fed removed much of its forward guidance was because he wants more flexibility going forward. It is also going to be easier, as every meeting is 'live' next year when Powell is hosting a press conference after every meeting. We believe the Fed will be able to continue hiking with one hike in H2 19 (i.e. three hikes next year and a total of five hikes from now until year-end 2019) . Markets are pricing in 3.75 hikes from now until year-end 2019 (i.e. including the hike next week).
To read the entire report Please click on the pdf File Below: