US Federal Reserve hails brighter outlook but keeps rates steady

The central bank left the door open to a rate hike later this year amid a strengthening jobs market and stronger spending.

The US Federal Reserve kept rates on hold as expected, but left the door open to a hike later this year. Picture: AP Photo/Manuel Balce Ceneta.

The US Federal Reserve has left the door open to an interest rate hike later this year, initially sending the US dollar higher and putting pressure on the Australian currency before a sharp reversal that saw the Aussie bounce.

At its monetary policy meeting overnight, the Fed described a brighter outlook for the US economy and appeared less worried about local and global risks than the last time it met.

Although the central bank kept interest rates on hold at the 0.25 per cent to 0.5 per cent range, as widely expected, the more upbeat tone suggests the possibility of a rate rise at its September or December meetings.

The US dollar rose earlier against a basket of currencies in anticipation of higher rates, with the dollar index adding 0.1 points at 4.50am (AEST), before falling back to minus 0.15 points by 6am. The Australian dollar fell to US74.64c at 4.50am, from US74.70c yesterday, before bouncing to US74.80c by 6am.

Wall Street spent much of the morning in modestly negative territory and was little changed immediately after the statement was released, before bouncing slightly then slipping back to close broadly steady. The Dow finished just 0.01 per cent lower, while the S & P 500 edged down 0.1 per cent.

US government debt also moved modestly after the statement. The yield on the 10-year Treasury note rose from 1.530 per cent just before the statement to 1.558 per cent, as traders initially sold bonds that seemed less attractive given the prospect of looming higher rates. But buyers soon pushed yields back down to 1.522 per cent by around 4.30am (AEST).

The central bank’s last meeting in June was clouded by a disappointing May jobs report, which showed the economy adding only 11,000 jobs in the month and caused commentators to question whether the Fed would be able to hike at all during 2016.

But a much improved June report, where payrolls increased by 287,000, prompted the Fed to declare overnight that the labour market had “strengthened” and that “job gains were strong in June following weak growth in May”. On balance, the Fed said recent months had seen “some increase in labour utilisation”.

The statement also assessed economic activity as “expanding at a moderate rate” and said household spending has been “growing strongly”, two positive notes that could encourage the bank that the economy is strong enough to handle higher interest rates.

The bank also said near-term risks to the economic outlook had “diminished”, possibly a sign of easing worries after the global market volatility sparked by Britain’s vote last month to exit the European Union.

The Fed has been very cautious in its path to increase rates, after lifting the benchmark rate from near-zero levels in December, where it had remained since the GFC. Fed officials originally expected four increases during 2016 but so far there have been none, as worries such as the disappointing jobs print and market volatility sparked by slowing growth in China have weighed. The bank had also been hesitant to move amid the uncertainty leading up to Britain’s referendum, although it could be encouraged that global markets have calmed and rallied in the wake of the initial shock.

Given the bank’s historic caution, traders now see a hike in September as less likely than a December move. The market is pricing in an 18 per cent chance of a September increase, according to CME Group, compared with a 37 per cent chance of a move in December.

On the downside, the Fed warned that business fixed investment was “soft” and that inflation remained below its 2 per cent target, saying inflation expectations had changed little in recent months. Continued lacklustre inflation could give the bank pause in its plans to tighten policy.

Economic activity is set to expand at a moderate pace, the jobs market will strengthen and inflation will remain low in the near time but rise to 2 per cent in the medium term, the Fed expects.

The bank said it would continue to closely monitor economic conditions and global developments.

Fed chair Janet Yellen will speak on August 26 at Jackson Hole, and her comments will be closely parsed for possible clues about the path of policy.

Only one member of the Federal Open Markets Committee dissented from the decision, with Kansas Fed president preferring to raise rates 25 basis points this meeting.

With Dow Jones