Fed policy meeting in focus this week

The United States Federal Reserve — probably the most important central bank in the world — holds eight regularly scheduled policy meetings a year, and its fifth of the year is due to be held tomorrow and on Wednesday.

Markets are not expecting the Fed to raise interest rates so soon after its last hike in June. In fact, the futures market is not even anticipating a rate hike until early next year.

However, this may reflect market complacency given the soft US inflation data and slowdown in the US economy in the first quarter of this year. The Fed is of the view that this is transitory, and a pick-up in the economy and inflation in the coming months could change the market’s views about future Fed rate hikes.

The first estimate of the second-quarter US economic performance will be known this Friday, and will have a bearing on the outlook for US monetary policy.

Markets are expecting US economic growth to show a significant rise to 2.6 per cent in the second quarter compared to 1.4 per cent in the first quarter, fuelled by solid hiring and an uptick in consumer spending.

More than just the second-quarter GDP performance, markets will also pay attention to the core Personal Consumption Expenditures (PCE) Price Index, which is the Fed’s preferred inflation gauge. The central bank has a 2 per cent target for this measure of inflation. A pick-up in inflation would also change the market’s views about future rate hikes.

The core PCE Price Index growth has retreated from highs of 1.8 per cent to 1.4 per cent over the past few months. The consensus view within the Fed is that the past three monthly readings of core inflation have been held down by idiosyncratic factors, including huge declines in mobile phone service plans and prescription drug prices.

These are largely transitory factors that should fade in coming months.

Markets seem complacent about US monetary policy. We expect one more rate hike in September, and the start of quantitative tightening in December.

Our current projection is for three to four rate hikes in 2018, followed by three hikes in 2019.