OVERVIEW

• The Fed retains its view of raising interest rates this year albeit at a gradual pace.
• The Fed's interest rate forecast implied two 25-bp increases before the year ends
• Economic assessment mostly upbeat but trims GDP forecast
• This turns up heat on capital outflows in the emerging markets including Malaysia, suggesting further downward pressure on the ringgit.

The FOMC message: still on course for hiking rates later this year. The Fed has said it anticipates that the economic data will allow it to raise rates later this year. Its Chairman Janet Yellen said that far too much attention is being placed on the timing of the first rate hike when what's far more important is the pace of tightening, and at this point it's projected to be quite slow. There were no dissents for the fourth consecutive meeting.

Fed's dot plots implied two rate hikes this year. Just 2 out of 17 FOMC members see the central bank holding off on rate hikes until 2016. The expected pace of hikes has slowed a bit, with the Fed now seeing the Fed Funds rate at 1.625% (median) by the end of 2016 (vs.1.875 at the March forecast). The projection for end-2015 remained at 0.625%, suggesting two rate hikes between now and then. The long-run equilibrium rate was left unchanged at 3.75%, where it has been since last June. Though it does not necessarily mean a hike in September and December, it does seem to be a strong suggestion of a September move, barring a significant downside surprise in the key economic indicators. Though the FOMC's central tendency calls for two hikes Fed Funds futures continue to price in just one rate hike this year.

The GDP forecasts have been trimmed in spite of potential hikes this year. The Fed cut its 2015 GDP growth forecast range to 1.8%-2.0% from the 2.3%-2.7% March forecast. A small change was seen for 2016 and 2017. 2016 GDP growth is now seen at 2.4-2.7% vs. 2.3-2.7% in March.

Its economic assessment was mostly upbeat. It recognized that the economy is expanding "moderately" after nearly stagnating in 1Q15. Though believing Q1's slowdown to be transitory, "my colleagues and I would like to see more decisive evidence that a moderate pace of economic growth will be sustained," says Yellen. The housing market and exports are still soft. Inflation is low, but survey-based measures of inflation expectations remain stable. The other parts of the statement were virtually unchanged. It noted that the slack in the labor market has "diminished somewhat,” but noted plenty of work still need to be done as the labour force participation rate remains at historical low. The latest forecast shows an unemployment rate of 5.2%-5.3% this year, which is up from 5.0%-5.2% forecast in March. The 2016 and 2017 forecasts were left unchanged at 4.9%-5.1% for both years.

Source: Kenanga Research - 18 Jun 2015