Citigroup economist Andrew Hollenhorst is convinced the US Federal Reserve will start increasing interest rates late next year.
Citigroup economist Andrew Hollenhorst is convinced the US Federal Reserve will start increasing interest rates late next year.

Dots plot course for US rate rises: Citigroup

The Federal Reserve won't say when it plans to start winding back its money creation and near-zero Fed funds rate that have helped boost the US sharemarket to record highs.

But Citigroup global markets chief US economist Andrew Hollenhorst is convinced the Fed will start "tapering" the pace of its asset purchases - currently set at $US120bn ($154bn) a month - in the December quarter and then start increasing interest rates late next year.

Mr Hollenhorst said Wall Street took a "dovish signal" from the fact that the median "dot plot" interest rate projection of Federal Open Market Committee members stayed at the "zero lower bound" after their March policy meeting, despite massive new US fiscal stimulus.

That saw the S&P 500 rise 0.4 per cent to a record high of 3983.87 points on Wednesday.

But the US 10-year bond yield stayed buoyant after hitting a 14-month high of 1.6868 per cent before the outcome of the FOMC meeting early on Thursday Australian time.

Along with Australia's better than expected employment data for February, upward pressure on US 10-year bond yields saw the equivalent Australian yield spike 11 basis points to 1.833 per cent. Australia's S&P/ASX 200 index fell 0.7 per cent to a five-day low of 6746.9 points, with highly priced "growth" stocks in the health and IT sectors coming under pressure along with "bond proxies" in the utilities, real estate and industrials sectors.

Fed chairman Jerome Powell clearly was not among the central bank officials looking for rate increases by 2023.

He said the "strong bulk" of the committee did not see increases - although their number fell to 61 per cent, from 71 per cent in ­December - and the dots were not promises nor predictions.

But the dots are "clearly shifting up" with five expecting three or four increases by the end of 2023 and three expecting at least one rise in 2022, according to Citi's Mr Hollenhorst.

Seven of 18 Fed officials saw at least one rate rise in 2023, versus five of 17 in December.

Even with President Joe Biden's $US1.9 trillion ($2.5 trillion) fiscal stimulus now projected to see US economic growth surge to 6.5 per cent this year (from 4.2 per cent previously forecast), unemployment fall to 3.5 per cent by 2023, and core inflation slightly above its 2 per cent target for the next three years, the world's most powerful central bank said it expected to keep its Fed funds rate near zero until it achieved "maximum employment" and inflation was above 2 per cent and on track to exceed it for "some time".

The Fed vowed to keep buying "at least" $120bn of US Treasuries and mortgage-backed securities per month "until substantial further progress has been made" towards its "maximum employ­ment and price stability goals".

It also remained "prepared to adjust the stance of monetary policy as appropriate if risks emerge" that would impede the attainment of its goals.

Mr Powell repeated it would be "some time" before the economy achieved the "substantial further progress" that the Fed wants to see before starting to taper its asset purchases. He declined to define that, but said it would only be appropriate to give guidance that tapering was on the table when data suggested substantial further progress would be made.

Mr Hollenhorst said: "I would say by any definition of 'substantial further progress', you will have that by the end of this year.

"If you just look at the Fed's forecasts … a relatively low unemployment rate, you will have closed most of the output gap by the end of this year into 2022. The issue that we have is that the Fed hasn't given us a definition."

The monthly economic data - particularly jobs and inflation - will therefore be super important for picking "if and when Fed officials guide towards tapering".

"We continue to expect tapering of asset purchases to begin in the December quarter and will be listening carefully to Fed responses to incoming data to understand if 'substantial further progress' is coming into view," Mr Hollenhorst said. "Overall the meeting reinforces the idea that the Fed will only raise rates once inflation has overshot 2 per cent more substantially or for longer."

But Fed officials may be in for a surprise on the strength and durability of core inflation beyond the well-expected transitory price rises and base effects of 2021, according to Citi.

"Whether the Fed in fact raises rates in late 2022, as we expect, will depend on whether core inflation follows our forecast path to stay stably above 2 per cent for not only 2021 but also 2022," Mr Hollenhorst said. "Also important will be if rising inflation expectations show this overshoot is durable or even is risking a more concerning overshoot of the Fed's 2 per cent target."

In his view the Fed wants to be sure the economy will reach its goals before tapering, not least because it wants to avoid a repeat of the "taper tantrum" of 2013.

Rising bond yields hit the US sharemarket that year and economic data subsequently weakened, leading the Fed into an embarrassing delay in the start of tapering.

BlackRock's Rick Rieder also said the Fed would start tapering sooner than expected. The CIO of fixed income for the world's biggest fund manager said the Fed might communicate its plan as early as its June policy meeting.

"Tapering at the front end of the yield curve … can have real benefits to savings for consumers and investors," he said.

Originally published as Dots plot course for US rate rises: Citigroup


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