US Fed takes a step towards higher rates

The Fed has taken another small but important step towards preparing the markets for higher US interest rates. The January FOMC statement dropped the reference to maintaining policy accommodation for a 'considerable period.' Instead, the statement now says that the Fed 'can be patient in removing its policy accommodation.' There will doubtless be long arguments about exactly what this change in language means. But the initial reaction of traders - that it is more hawkish - is surely right. Given that there was no need for the Fed to change its language, the decision to change must be meant to signal something.

It is also worth stressing that this is the second important change in as many months. In December, the Fed changed the wording of the 'bias' to say that the probability of a fall in inflation was now 'almost equal' to the risk of a rise. It kept that wording this time, probably because switching to a neutral bias as well as dropping the 'considerable period' would be too much in one go. But an increasingly plausible path to a summer rate hike is now: neutral bias in March, tightening bias in May, rate hike in June.

The only other change in the statement was the comment on the labour market. The Fed now says that 'although new hiring remains subdued' (presumably a reference to payrolls) 'other indicators suggest an improvement in the labor market.' That is just a small adjustment to the December statement, where 'the labor market appears to be improving modestly.' The rest of the statement was the same word for word, including the comment that 'increases in core consumer prices are muted and expected to remain low.' That is some consolation for the 'doves', though the Fed has to say this now or critics would ask why it has not already raised rates.

In any event, the economic numbers will still decide the pace of Fed tightening. The divergence between strong leading indicators and disappointing hard data continued on Wednesday. Durable goods orders were unchanged in December, failing to rebound from a 2.3% fall in November. Nonetheless, there is plenty of time for those numbers (and others) to recover in time for a June rate hike. A big rise in the January payrolls released next Friday could be the next important step: our forecast is for a 300k rise.