Rationale behind 'no Fed hike' in September and growth-inflation projections for 2016

On U.S. Job market: On the labor market front, the unemployment rate has fallen sharply and at 5.1% is already through the Fed's YE 15 forecast. At the same time, however, there has been no uptick in wage growth this year. Hence, on balance, we believe the Fed is likely to convey that labor market slack continues to diminish amid moderate growth.

On inflation: The U.S. inflation should move towards the Fed's 2% target and the progress is likely to be more gradual than expected earlier. Further, with market implied breakevens falling sharply over the past few months and a modest drift down in survey expectations over the past few years, some Fed participants may see greater uncertainty to their assumption about the stability of inflation expectations. Against this backdrop, we believe the Fed is likely to wait to gain confidence in the inflation outlook before hiking.

All of these are likely to weigh on the Fed's 2016 inflation forecasts, which at 1.75% were already high relative to the Fed staff forecast of 1.6% at the June meeting.

At the June meeting, as shown in the diagram the Fed forecast real GDP growth of 1.9% in 2015, rising to 2.55% in 2016 and YoY core PCE inflation to rise significantly to 1.75% by YE-16 from 1.35% at YE-15. With growth in the first half now looking better (at 2.15%), the Fed is likely to increase its 2015 forecast. However, at the same time, the tightening in financial conditions since the June meeting should weigh on 2016 forecasts.