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23 Feb 2016
US: The risk of a reversal – Goldman Sachs
Research Team at Goldman Sachs, suggests that the Fed officials continue to signal rate increases for later this year, but financial markets are increasingly focused on the risk of a policy reversal.
Key Quotes
“Market pricing implies only about a 50% chance of a rate hike in 2016, and a 30% chance of a cut. Even considering downside risk scenarios, markets may be overestimating the chances that the Fed reverses course.
Policy reversals—lowering rates shortly after an increase, or raising rates shortly after a cut—are surprisingly uncommon in the data. Across G10 economies since 1990, we find only five policy reversals in 85 cycles—the other 94% of the time policy trends continue for at least a half year.
Academic research suggests two reasons for the infrequency of policy reversals in the data. First, central bankers may be averse to changing course for communication- and credibility-related reasons. Second, the tendency toward gradualism—changing policy incrementally in response to incoming data— creates optionality, and helps avoid reversals.
Outside of a recession scenario, the hurdle for Fed rate cuts any time soon is quite high, in our view. However, a reduction in the “dots” at the March FOMC meeting would be a natural response to recent market developments.”
Key Quotes
“Market pricing implies only about a 50% chance of a rate hike in 2016, and a 30% chance of a cut. Even considering downside risk scenarios, markets may be overestimating the chances that the Fed reverses course.
Policy reversals—lowering rates shortly after an increase, or raising rates shortly after a cut—are surprisingly uncommon in the data. Across G10 economies since 1990, we find only five policy reversals in 85 cycles—the other 94% of the time policy trends continue for at least a half year.
Academic research suggests two reasons for the infrequency of policy reversals in the data. First, central bankers may be averse to changing course for communication- and credibility-related reasons. Second, the tendency toward gradualism—changing policy incrementally in response to incoming data— creates optionality, and helps avoid reversals.
Outside of a recession scenario, the hurdle for Fed rate cuts any time soon is quite high, in our view. However, a reduction in the “dots” at the March FOMC meeting would be a natural response to recent market developments.”