Moving into the 2nd half of the year statements from the US Federal Reserve will become more and more important for the US dollar and treasuries. The inevitability of a ‘normalisation’ of interest rate policy, by central banks across the developed world, is inevitable. The only question is the timing.

The Federal Open Markets Committee are not going to be pulling that particular lever, and increasing rates from their historic lows just yet, but this week’s Fed meeting minutes will flesh out just why that is the case.

June’s meeting came with additional and revised economic forecasts that were fleshed out during the press conference. We noted at the time that the Fed’s inflation expectations were surprisingly low. By the end of 2016 PCE – Personal Consumption Expenditure, the Fed’s preferred inflation measure – is only predicted to have risen to 1.6%. Unfortunately for the doves on the Committee, we saw the latest PCE reading hit that exact number a week later.
But, of course, one month’s reading will not cause an immediate change to forecasts. It will be interesting to see how many members are looking for an increased upward pressure on inflation from wages in a tightening labour market. In the past 3 months, it has added 816,000 jobs – slightly less than the population of Columbus, Ohio. These are a huge numbers for an economy that supposedly shrank by an annualised rate of the 2.9% in the first 3 months of the year, courtesy of the horrendous weather it suffered.
With these improvements the unemployment rate has fallen to 6.1% in the United States. It was 7.5% 12 months ago. Even only 2 weeks ago, the Federal Reserve had only thought that we would see this kind of strength by the end of the year.

That being said we did see the Fed’s overall path of interest rate expectations shift higher from March, with the median prediction seeing rates at 2.5% by the end of 2016. The longer-run equilibrium rate came lower to 3.75% from 4%, however, perhaps reflecting the popular thinking that rates are unlikely to reach the levels seen pre-crisis.

Hopefully we also get to see what the Fed Committee thinks of low volatility in asset markets. Overall volatility has been driven lower by global central bank asset purchases programs and the subsequent search for yield. We do expect that volatility will pick up eventually – thankfully – but apart from a exogenous market shock, it will be a normalisation of interest rates and monetary policy that will do it.

We know that there was some discussion around the Fed’s plans for an exit strategy from investments made as part of their quantitative easing program. We don’t expect this to begin until 2016, once interest rates have been taken higher. We would suspect that the publication of the minutes will be slightly USD positive on Wednesday, but for a wider appreciation of the ‘greenback’ only increased inflation expectations will do.