ABN AMRO strategists analyze the latest Federal Reserve decision to keep the federal funds rate at 3.5-3.75%. They highlight dissenting votes, Kevin Warsh’s emphasis on the 2% inflation target, and the Fed’s reliance on market signals. They expect rates to stay on hold in coming months but warn that high Oil prices could still trigger a September hike.

Fed holds but keeps hike risk

“The Fed decided to leave its target for the federal funds rate unchanged at 3.5-3.75%. This was in line with our own expectations and those of the vast majority of economists. However, few would have seen the hold as a done deal.”

“The only take away, is that the FOMC remains more concerned about the inflation side of its dual mandate, rather than the full employment part. It noted that ‘job gains have kept pace with the workforce, and the unemployment rate has changed little’ but that ‘inflation remains elevated relative to the Committee’s 2 percent goal’. Against this background, it stressed its commitment to ‘deliver price stability’.”

“He [Warsh] stressed that the Fed did not have ‘a soft target’, it had a hard 2% target and the Fed would ‘not waiver’ in taking the right actions to achieve it. Part of this ‘hawkish’ communication might be designed to directly anchor inflation expectations, which the Fed Chair noted would partly also determine the inflation outlook.”

“It seems that the FOMC is taking the market signal to be – at least on the basis of recent data – that policy rates should eventually go higher. At the same time, higher rates were doing the Fed’s tightening job for it, which could be interpreted as making actual hikes less necessary.”

“Overall, the Fed clearly left the door for an interest rate hike in September wide open. However, a lot will depend on the data between now and then.”