An increase of 0.3% in US core inflation in May is not expected to prevent the Federal Open Market C...
An increase of 0.3% in US core inflation in May is not expected to prevent the Federal Open Market Committee from cutting interest again this month.
The monthly figure was met with some selling in the bond market on disappointment that it was not even lower, but the annual increase of just 1.6%, well below the Fed's 2% target rate, suggested the figures present no barrier to easing.
The 90-day bank bills market has priced for a rate cut of 25-50 basis points following the Fed's two-day meeting, set down for 24-25 June.
If delivered, it would be the first rate cut since November last year, when the key Fed funds rate was sliced by 50 basis points to 1.25%.
Threadneedle head of government bonds Sandra Holdsworth said she expects the Fed will maintain a doveish stance in the statement accompanying any rate cut.
'It wants to keep the whole level of the yield curve fairly low, because they want to stimulate consumer demand and the only way to do that is to put more money into people's pockets by making their mortgage payments lower,' she says.
'But mortgage rates are linked to long-dated, not short-dated bonds, so the Fed is not just targeting the short end of the yield curve and if they feel bond yields are too high they will use unconventional measures.'
Fed governors have previously suggested the central bank may repurchase long-dated Treasuries if manipulation of cash rates is not sufficiently stimulatory, but have given no indication of the circumstances likely to trigger such a policy response.
'Whether they would use unconventional monetary policy tools before lowering rates to zero is uncertain,' Holdsworth says.
'But they have highlighted the fact that these measures are unusual, and would be used at times when conventional easing was not working, so there doesn't seem to be a precondition for rates to be at zero before they use them.'
Jupiter head of fixed interest John Hamilton said the Fed may be using the suggestion of government bond repurchases to keep yields subdued at the long end of the curve, while having little intention of following through.
'The Fed still wants to keep a fairly cautious attitude, because it wants to maintain low bond yields in order to conjure up a recovery in the US,' he says.
'By talking about the risks of deflation, it has managed to get bond yields down, and thus avoid deflation. I think it believes it won't have to use the unconventional measures if it continues to talk the bond market up,' he adds. The Fed is also waiting for some clarity on the economic outlook and the impact of the policy action taken to date.
'It doesn't know yet whether the policy action it has already taken is sufficient to keep deflation at bay, and until the picture becomes clearer it will continue to talk dovishly,' he notes.
Meanwhile Holdsworth said UK inflation data for May showed some reduction from April, increasing the likelihood of a UK rate cut when the Monetary Policy Committee next meets on July 9-10.
US inflation below 2% target in May.
Bank bills pricing for 25-50bp easing.
UK May inflation lower than expected.
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