Fed to hike over two distinct stages - BAML

FXStreet (Guatemala) - Analysts at Bank of America Merrill Lynch explained that an increasingly popular view of the Fed is that they will hike rates in two distinct stages.

Key Quotes

“The idea is that they want to get away from the zero lower bound to "reload" their policy ammunition and to minimise distortions to financial and economic behaviour; however, they do not want to go too far as the economy cannot handle a full tightening cycle. Hence, the argument goes, the Fed will start tightening relatively early-say, next spring-but then rates will plateau for an extended period-say, with 2% nominal and 0% real rates."

"Before we start dancing the policy polka, it is worth noting that a two-step exit is not consistent with any models of central bank behaviour we have seen. In our view, it rests on three key assumptions. First, it assumes the Fed has a good idea exactly where it is going when its starts hiking rates."

"In this instance, presumably the Fed is confident that the natural real rate of interest is at least zero, but they are not sure how much higher it is. Hence they move to a zero real rate (and 2% nominal rate) and then reassess."