Federal Reserve raises rates, keeps hike projections broadly unchanged

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The Federal Reserve raised interest rates for the third time in the calendar year at its December meeting on Wednesday, as expected, while keeping its expectations for hikes in 2018 broadly unchanged.

The US central bank raised its Fed funds rate by an additional 25 basis points to a range between 1.25-1.5%, in line with consensus, with all but two of the voting members on the rate-setting committee supporting an immediate rate increase. With a hike in December fully priced in going into the meeting, investors were instead focusing on the tone of communications in both the statement and press conference from outgoing Chair Janet Yellen and the release of the latest ‘dot plot’.
The statement itself was little altered from the previous meeting in November. Policymakers continued to cite a strong labour market and growth in both household and business spending. Inflation forecasts were kept unchanged, although the central bank now expects the US economy to grow by 2.5% in 2018, a significant upward revision from the previous 2.1% forecast.

In her final press conference as Chair of the Federal Reserve before being replaced by Jerome Powell in February, Yellen was equally upbeat on the state of the US economy, saying it is ‘performing well’. She also stated that tax changes by the Trump Administration, should they be enacted, would tend to provide ‘some modest lift to GDP growth in the coming years’.

Meanwhile, the latest ‘dot plot’, which shows where each member of the committee expects rates to be at the end of each year, continued to show that policymakers expect rates to be raised on multiple occasions next year. The median forecast for hikes shows that the Fed continues to expect rates to be raised on three additional occasions in 2018 and two in 2019 (Figure 1), unchanged from the last set of projections in September.

Figure 1: FOMC December ‘Dot Plot’

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Source: Federal Reserve Date: 13/12/2017

Despite the overall hawkish message from the Fed on Wednesday, the greenback fell by over half a percent against most of its major peers in the aftermath of the meeting (Figure 2), with FX markets instead focusing on the two members of the committee that voted to keep rates steady. However, given the two members and well known doves, we think the reaction was somewhat unwarranted and should not materially impact the pace of hikes in the US in the coming months.

Figure 2: EUR/USD & GBP/USD (13/12/2017 - 14/12/2017)

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Source: Thomson Reuters Datastream Date: 14/12/2017

Crucially to the US Dollar, the market is still only pricing in two rate increases in the US in 2018, one in March and another in September. This remains a slower pace than the Fed’s ‘dot plot’ would suggest and we think there is scope for an appreciation in the greenback next year as market expectations become more in line with that of the FOMC.

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