Chart of the Week: Fed turns dovish (again), but summer rate hike not impossible

It was no surprise that the FOMC left interest rates unchanged last week, but the cuts to members’ projections of the federal funds rate (or the so-called dot plot) took markets by surprise. Treasury yields dipped and expectations of a rate hike in July fell below 10%.

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Less than a month has passed since FOMC members began talking up the chances of a rate hike this summer. However, these chances seem to have been dashed by the poor nonfarm payrolls report for May and growing anxiety over the outcome of the UK’s referendum. During her press conference last week, Janet Yellen noted that both of these developments had been factored into the FOMC’s decision.

Although a rate hike in July now looks unlikely, it would be unwise to completely rule out the prospect of that happening. If the UK votes to remain in the EU (as the bookmakers’ odds still suggest is likely), and US payrolls rebound in June (as we expect), then a rate increase in the summer will suddenly come back into play. Admittedly, the cuts to the FOMC members’ interest rate projections send out a dovish message, but most of these cuts were for 2017 and beyond; the median estimate of two rate increases in 2016 was unchanged.

In reality, the short-term outlook for US monetary policy is likely to hinge on the outcome of Thursday’s UK EU referendum and subsequent financial market response.