Week ending 18th June 2021.

The world’s most important central bank, the Fed, has been this week’s main focus as policymakers met to decide US monetary policy.

The accompanying statement was much more hawkish than we expected, especially the shift in the Fed’s ‘dot plot’ (which shows each policymaker’s interest rate forecast for each of the next three years).

In fact, the dot plot was a complete bolt from the blue:  the median projection is now for two interest rate increases in 2023, up from none just three months ago – and two policymakers see six increases!

This big jump in the dot plot doesn’t make any sense to us as it doesn’t match the very small changes they made to their inflation forecasts:  2022 inflation expectations are now 2.1% versus the 2.0% they forecasted in March; while 2023 forecasts remained at 2.1%.

Moreover, the dot plot and inflation forecasts are now completely inconsistent with the Fed’s targets:  at the end of last year, the Fed changed its inflation target from 2% to one that averages 2%.  This change was designed to allow inflation to overshoot 2%, to enable it to make up for the time it has spent running below 2% – unless, of course, policymakers consider the current small inflation overshoot as sufficient to make up for the fact that inflation has averaged just 1.5% since the 2008/9 global financial crisis.

Furthermore, given that the Fed has stated that it would taper its QE program (bond purchases) well before it increases interest rates, this dot plot would suggest that their “we aren’t thinking about thinking about tapering” can no longer be the case:  given the timelines, they must be discussing tapering.

Mitigating this shocker, as we explained in our last Market Update (please see here), the dot plot is just a forecast and not a commitment (and historically the dot plot’s track record at forecasting interest rates is poor, as policymakers have tended to be overly hawkish).  Additionally, a couple of the more hawkish policymakers won’t be voting members by 2023.

Consequently, although global equity markets clearly didn’t like this hawkish surprise and fell over the week, we believe it is far too early to conclude that the current economic reflation is over and that we will see significantly higher interest rates in the coming years.

This is because what the Fed says is often far more important than what the Fed actually does – and so we wouldn’t be surprised if consumers’ inflation expectations start to come back down (especially as supply bottlenecks and reopening demand are already starting to fade), thus allowing the Fed to keep its monetary policy accommodative and allow the employment market to fully recover.

Looking ahead to this coming week, the focus is now firmly on each and every planned speech by a Fed policymaker, which include:  Jay Powell; Loretta Mester; James Bullard; Patrick Harker and Robert Kaplan.

Additionally we have a BoE monetary policy meeting – and it will be interesting to hear how policymakers view the recent economic and inflation data.

Data-wise, we have US, UK, Eurozone & Japanese PMI; UK & Eurozone consumer confidence; US durable goods orders; and US PCE (the Fed’s preferred inflation measure).

Investment Management Team