US shares crept higher last week, with the S&P500 Index adding 1.3%. In addition to China’s RMB500bil standing landing facility to Chinese banks last Tuesday, investors were also looking at the FOMC which was held last week. Macquarie Equities Research released a research article on 17th September expressing their views on the changes to FOMC forecasts and excerpts can be found below.

Changes to FOMC forecasts continue to support key aspects of MER’s view. First, potential output is far lower and the output gap far smaller than consensus suggests. Second, rates hikes should commence gradually (at a pace of 12.5 bp per meeting) in Mar 2015. Third, the yield curve should flatten as long-term rates are likely to continue to remain contained.
 
Continued downward revisions to growth forecast
In what has become a familiar theme lately, the FOMC’s real GDP growth forecasts were reduced, a development Chair Yellen indicated in her press conference attributed to reductions in potential output estimates.
 
First, the midpoint of the central tendency of 2015 real GDP growth was reduced to 2.8% (previously 3.1%), bringing the FOMC closer to MER’s view of 2.6% real growth in the quarters ahead. Second, a relatively low forecast of 2.4% was introduced for 2017. Consensus has long been of the view that the economy would grow at a 3%+ rate for several years. The introduction of a relatively subdued growth rate in 2017 suggests the FOMC does not share this perspective. Finally, there was once again a reduction in the “longer run” forecast number to 2.15% (previously 2.2%). This measure has been consistently reduced and has fallen nearly 50 bps over the last two years. The FOMC now expects real economic output in 2020 to be nearly 8% lower than it indicated in its 2011 projections.
 
Forward guidance stays, but rate projections rise
The committee kept its forward guidance, maintaining that a “considerable time” would pass between the end of QE3 and the first rate hike. Consensus interpreted this as an indication that a rate hike will not occur until at least the middle of 2015 and potentially even later and MER does not share this view. In her press
conference, Chair Yellen downplayed the strength and meaning of this commitment. What’s more, as was hinted at in July’s meeting minutes, an update of the plans for policy normalization was released. This made clear that the ending or phasing out of the reinvestment program will not occur until sometime after the first Fed Funds rate hike. This sequencing makes a rate hike in March 2015 more likely.
 
Finally, the committee’s average Fed Funds rate projections for end-15 rose modestly to 1.27% (previously 1.20%), indicating a more hawkish committee relative to June. A prudent adjustment to this measure is to remove the impact of the three most hawkish estimates to reduce the impact of regional reserve bank presidents who are more hawkish than the Fed Governors, but rotate as voters and therefore have less impact on the policy trajectory. Making this adjustment reveals a projected Fed Funds rate of 1.07% at end-15 (previously 0.92%). This measure has increased more rapidly over the last six months, suggesting that more moderates on the committee have been shifting their views in favour of an earlier rate hike. This level is also consistent with rate hikes of 12.5 bps commencing in March. Such a trajectory would mean the target range of the Fed Funds rate would be 1.00 to 1.25% at the end of 2015.

Source: Macquarie Research - 22 Sep 2014