More Fed hike doubters

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From BofAML via FTAlphaville:

The FOMC dot plot released last week showed the apparent convergence of participants’ views on the medium-term rates outlook. All but two participants project Fed hikes by the year-end, with a large cluster (41%) projecting exactly two hikes. On the surface, this seems to indicate the Fed is almost certain to start normalizing rates this year. And the rates market seems to think so. The Chart of the Day shows the probability distribution of the number of Fed hikes by year-end implied from Eurodollar option prices.

The implied probability of a no hike outcome is only 14%.

However, we believe the market underestimates the likelihood of such a scenario. If inflation, especially its core components, continues to decline, it would be very difficult for the Fed to be “reasonably confident” that inflation is on track to move back to the target over a medium-term horizon, in our view. As a result, we think the Fed may delay hikes if core inflation continues to decline this year. At the same time, the bulk of statistical evidence suggests inflation is poorly predictable, so the likelihood of a further decline in inflation could be substantial and, arguably, not very far from 50%. In particular, inflation may continue to decline despite the tighter labor market. Note that although we believe the market may underestimate the likelihood of no hikes this year, we do not think this is the most likely scenario. Our economists expect the Fed to start normalizing rates in September, consistent with our view.

This question is surely all about energy prices. US inflation will stabilise by year end as last year’s oil price crash passes “pig in the python” style through prices. So long as energy prices don’t fall further!

Hawkish governor Stanley Fischer spoke last night and said:

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  • *FISCHER: ECB QE PUTS DOWNWARD PRESSURE ON U.S. LONG-TERM RATES
  • *FISCHER: SIMPLE RULES CANNOT REPLACE JUDGMENT FOR FED POLICY
  • *FISCHER: LIFTOFF WHEN FED `REASONABLY CONFIDENT’ ON INFLATION
  • *FISCHER SAYS DOLLAR’S RISE ALSO REFLECTS RELATIVE U.S. STRENGTH
  • *FISCHER SAYS FUTURE FED RATE RISES WON’T BE SMOOTH UPWARD PATH
  • *FISCHER SAYS THERE’S UNCERTAINTY ABOUT LEVEL OF FUTURE RATES
  • *FISCHER: FED POLICY GUIDED BY DATA AND PURSUIT OF DUAL MANDATE
  • *FISCHER SAYS RATE LIFTOFF LIKELY WARRANTED BEFORE END-2015
  • *FISCHER: EXPLICIT FED FORWARD GUIDANCE TO DECLINE POST-LIFTOFF
  • *FISCHER SAYS STRONGER DOLLAR OFFSETTING SOME BENEFITS OF ECB QE

I would add as well that since the GFC the US economy has shown a very consistent pattern of weakness in the first half and strength in second, with some kind of Christmas effect apparent.

First rate hike for Q4 ’15 or Q1 ’16 is the best bet.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.