The Federal Reserve announced on Wednesday it was raising interest rates for the first time so far in 2018 following its two-day monetary policy meeting, Jerome Powell’s first as the new Chair.
As was universally anticipated, the committee voted unanimously to hike rates by an additional 25 basis points to a range between 1.5-1.75% as the central bank continues on its path of gradual policy normalisation. With fed fund futures showing that the market was fully pricing in a hike going into the meeting, investors were instead far more concerned with the release of the FOMC’s latest ‘dot plot’ for an indication as to the likely pace of further rate increases in the US in 2018.
As we had anticipated prior to the meeting, the ‘dot plot’, which shows where each member of the committee expects rates to be at the end of each year, was revised higher from the previous set of economic projections released in December, albeit only modestly. Policymakers in the US continue to expect to hike on three occasions in 2018, although median rate projections for 2019 and 2020 were shifted upwards. The committee now anticipates rates to end next year at an average of 2.9%, implying three hikes in 2019 compared to two expected in December, and 3.4% in 2020, up sharply from the previous 3.1% estimate (Figure 1).
Figure 1: FOMC March Meeting ‘Dot Plot’
Source: Federal Reserve Date: 21/03/2018
It is important to note that there is a fairly sizable disparity between the median and mean measures of future hikes in 2018. While the median estimate for hikes this year was more-or-less unchanged, there was a fairly sharp increase in the mean dot. This suggests to us that many of the voting members on the committee are open to the possibility of as many as four rate increases in the US this year.
The tone of communications in the bank’s statement also remained upbeat. The Fed argued that the US jobs market was ‘strong’ and that the economic outlook had ‘strengthened in recent months’. GDP forecasts were also revised higher, with the Fed now expecting growth of 2.7% this year versus the 2.5% estimate in December. Wording on the inflation outlook was also tweaked, although the overall outlook on price growth remained largely unchanged.
Despite the hawkish assessment from the Fed, the US Dollar slipped by around half a percent against both the Euro and the Pound off the back of the announcement (Figure 2). The market reaction suggests that investors’ expectations were very high going into the meeting and were much more hawkish than we had anticipated.
Figure 2: EUR/USD & GBP/USD (21/03/2018 -22/03/2018)
Source: Thomson Reuters Date: 22/03/2018
Both the statement and economic projections confirm to us that we’re likely to see a minimum of three interest rate hikes from the Fed in 2018, with a strong possibility of four should the inflation outlook improve. As we have emphasised in the past few months, we think that there is still a slight disconnect between market pricing for Federal Reserve hikes and that of the FOMC itself, particularly now that rate estimates for 2019 and 2020 have been shifted higher. We remain of the opinion that the US Dollar is due an upward correction once market pricing for Federal Reserve hikes comes more in line with the bank’s updated ‘dot plot’.