Stay braced for two more Fed hikes in 2017, say economists

Washington: The Federal Reserve will increase interest rates twice more in 2017 and begin shrinking its balance sheet before year’s end despite a clear downturn in the outlook for inflation, according to 43 economists surveyed by Bloomberg.

Results of the survey, conducted 5-8 June, showed economists expect a rate rise at the end of the Fed’s two-day meeting on Wednesday and another in September, followed by the start of balance-sheet unwinding in the fourth quarter. The economists had previously forecast hikes in June and December. That means expectations for tighter monetary policy firmed slightly even amid falling confidence that the Fed will reach its inflation target any time soon.

After a recent decline in the pace of price rises, just 11% of respondents said inflation will record three straight months at or above the Fed’s 2% goal this year, compared to 42% who made that prediction in March.

“There is a broader slowdown in core inflation that could lead to a persistent undershoot,” said Omair Sharif, senior US economist at Societe Generale in New York, who was among those most concerned by stalling prices. “The Fed needs to be more careful here with how they look at inflation.”

Though widely expected to raise rates this week, Fed policy makers are being pulled in two directions by a spirited drop in unemployment this year and a surprisingly listless reaction in wages and prices. Fed governor Lael Brainard, who championed a go-slow approach through 2016 before backing increases in December and March, has suggested she may cut her outlook for further moves in the second half of 2017 if weak inflation persists.

The annualized growth rate of average hourly earnings fell to 2.5% in May from 2.8% in February even as unemployment dropped to 4.3%, a 16-year low. In addition, the Fed’s favourite gauge of price pressures, after stripping out food and energy components, declined to 1.5% in the 12 months through April from 1.8% in February.

Despite that, economists are showing more faith than investors that the Fed will raise rates two more times this year—in line with projections policy makers updated in March. Prices in fed funds futures contracts imply a roughly 90% probability of a June increase, and then only about even chances for another hike this year.

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The stall in inflation did, however, prompt a shift in how economists view the risks around monetary policy. Overall, more respondents viewed those risks as roughly balanced, compared with two months ago when they worried more that higher-than-expected growth and inflation might disrupt the Fed’s outlook.In response to a separate question, economists indicated the biggest risk to the Fed’s economic outlook lay in the possibility that loose monetary policy might fuel asset bubbles that threaten financial stability.

Regarding plans to shrink the $4.5 trillion balance sheet, 67% said the Fed would start after two more rate hikes, and, initially, reduce the balance sheet by $11 billion a month—$6 billion from Treasuries and $5 billion from mortgage-backed securities.

Economists stuck with their previous forecast that the fed funds rate would peak in this cycle at 3%, but moved back by six months the expected timing of that peak to the fourth quarter of 2019. Bloomberg