RBSM: Change to RBS Fed Call: No Rate Hikes for the Foreseeable Future

From the FXWW Chatroom: In the wake of the Brexit vote, we no longer expect the Fed to hike rates in 2016 and, for now, are removing any tightening from our 2017 forecast as well. While we think the hurdle for a rate cut — or more Fed accommodation of any kind — at this time is quite high, we are no longer confident that the next Fed move will be to hike. The timing and direction of the next move will depend on how destabilizing the Brexit vote ultimately is to financial markets and the global economy.

Importantly, our updated Fed call does not reflect a substantially more pessimistic view about the US economy. That said, even under a “best case” scenario (one in which financial markets settle fairly quickly), increased uncertainty in the wake of the Brexit vote is likely to lead to somewhat slower US growth in the second half of 2016 and into 2017 as well. In particular, we expect weaker business spending (and hiring), with some spillover to the consumer sector. The likelihood of weaker global growth and a stronger US dollar also suggests lower exports and a somewhat larger drag from trade. We will wait until the dust has settled a bit before finalizing our real GDP forecasts, but our 2016 (Q4/Q4) real growth estimate seems likely to be trimmed to 2% from 2.1% (since we are already halfway through the year, downward revisions to 2016 are less pronounced). In 2017, our real GDP forecast may be shaved by around 1/4 percentage point, from 2.6% to around 2-1/4%
Rather than a substantially more negative growth outlook, the change in our Fed call reflects our opinion that the downside risks associated with Brexit will persist for an extended period of time, and the existence of those risks will keep the Fed on hold for the foreseeable future. Fed Chair Yellen has repeatedly espoused a risk management approach to policy. Even before Brexit, the Fed saw “considerable uncertainty” with the outlook and signaled no urgency to act. In the wake of Brexit, uncertainty has not only increased, but is also likely to prove more lasting. Looking beyond the US presidential elections in November, political risks in the euro area will extend well into 2017, with national elections required in both France (by May 2017) and Germany (by October 2017), and potential EU referendums in other nations (e.g. Sweden) as well. In addition, monetary policy divergence (with easing now expected from the BOE, ECB and BoJ) should keep upward pressure on the dollar, which in turn will fuel concerns over a potential China devaluation. Against this backdrop of persistent global uncertainty, we find it hard to believe Fed Chair Yellen would feel comfortable enough to consider hiking rates in the foreseeable future. So while rate hikes at some point may be possible, the timing is sufficiently distant (and global developments sufficiently uncertain) that we see no value in forecasting additional hikes at this time. Moreover, under a “worst case” scenario (one in which the fallout from Brexit is greater than expected), a change in direction from the Fed cannot be entirely ruled out.
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