Chart of the Week: Give Them an Inch, and They Will Take a Mile

Last week’s Federal Open Market Committee meeting coincided with both a press conference, and an updated summary of economic projections. It gave participants of the Federal Reserve Board their first opportunity to record, formally, how recent financial market gyrations have shaped their views about the economic outlook.

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Having witnessed the equity market sell off that took place through January and into February, and having digested the Minutes of the January FOMC meeting, a downward revision to the level of the fed funds rate seen as appropriate for the end of this year appeared almost inevitable. In that respect, the Committee did not disappoint. Back in December 2015, the median projection was consistent with four 25 basis point increases in the policy rate through this year. By March 2016, only two were penciled in.

Whether it is because investors sensed an even more dovish tone at the accompanying press conference, or whether it is because there is now a growing belief that the FOMC will always under-deliver relative to its published guidance, the short-end of the US dollar curve has flattened still further. By close of business Friday, market pricing was consistent with just a single 25 basis point tightening in each of the next three years. Although the FOMC has given ground, in the eyes of investors it has not gone nearly far enough. Give them an inch, and they will take a mile! The gap between the level of the fed funds rate implied by the ‘dots’ curve at the end of the FOMC’s forecast horizon, and that implied by market pricing, is almost as large as it has ever been.