When will the Fed move next?

The US Federal Reserve has tightened its monetary policy position for the first time in nearly a decade in a move reflecting little change in the central bank’s policy but greater consensus among its members.

As expected, the Fed lifted its target for fed funds by 25 basis points in a unanimous decision, reflecting its confidence in the US economy’s recovery and a belief it will be able to withstand a gradual increase in rates. Now market focus will turn to its next move.

"[The rise reflects] little change in the central bank’s policy but greater consensus among its members."
Tom Kenny, Senior international economist, ANZ

ANZ research expects the next hike to come in the second quarter of 2016 and from then on is forecasting a more gradual tightening cycle than the Fed (although steeper than the general market).

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Our forecasts anticipate the Fed to set the fund rate between 1.0 per cent 1.25 per cent by the end of calendar 2016 and by an additional 50 basis points by end 2017.

The ongoing slowdown in China (and other emerging markets) added  is likely to provide ongoing headwinds to growth and inflation over the medium term, leaving the risks skewed towards a more drawn out recovery in inflation, especially given persistent oversupply in key commodity markets.

For its part, the Fed said the timing and size of potential future adjustments would likely be reliant on “realised and expected economic conditions relative to its objectives of maximum employment and two percent inflation.”

Any move will be gradual, although the way markets are currently interpreting the word is clearly creating tension, with the US yield curve implying rates well below what the Fed is currently forecasting over the next few years.

We expect markets to be very sensitive to the news flow in the US between now and mid-to-late March. The next Fed meeting is in late January which seems too early for markets to focus on. But if the data and Fed rhetoric suggests March is possible for the next hike, then the slope of the Fed’s trajectory is starting to look quite different from the market's current sense of gradual.

Tom Kenny is a senior international economist at ANZ

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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