• Fed raised its benchmark interest rate by 25bps to a range of 1.5% to 1.75%

• Fed continues to project three rate hikes in 2018

• GDP forecast raised higher

• The Fed feels they finally have the wind at their back

As widely expected, the Federal Reserve lifted a key US interest rate, but it stuck to a script for three rate hikes in 2018 even as it gave a more upbeat forecast for the economy. The Federal Open Market Committee (FOMC) raised its federal funds target rate range by 25 basis points to between 1.5% and 1.75%. That is the sixth 25bps move since December 2015.

In the first meeting of Fed Chairman Jerome Powell, the central bank avoided sending any overtly hawkish signal about its interest-rate policy. The Fed stuck to its December forecast of three interest rate hikes this year, but the central bank did push up their expected rate path in 2019 and 2020, however.

The Fed’s resolve to normalize interest rates clearly trumped any concerns about disappointing first quarter economic data. The opening paragraph of the FOMC policy statement readily acknowledges economic activity has been rising at a moderate rate and “household spending and business fixed investment had moderated from their strong fourth quarter readings.” Most notably, the statement noted that “the economic outlook has strengthened in recent months”. The slight downgrade to recent economic conditions was offset by an upgrade to its assessment of the labor market, where “job gains have been strong” and the “unemployment rate has remained low”.

This was also reflected in upgraded forecasts for real GDP growth in the Survey of Economic Projections (SEP). The median projection for 2018 rose to 2.7% from 2.5% and increased to 2.4% from2.1% for 2019.

Alongside faster economic growth, members lowered their expectation for the unemployment rate and nudged up their projections for inflation. The expectations for the unemployment rate were lowered by 0.1 percentage point in 2018 to 3.8% whilst the unemployment rate is now expected to trough at just 3.6% in 2019 from 3.9% previously, where it is expected to stay through 2020, down from 4.0% previously. The median expected rate over the longer-term edged down to 4.5% from 4.6%.

The median estimate for core PCE inflation rose to 2.1% for 2019 and 2020, both up from 2.0% previously. The median expectation for the federal funds rate was unchanged in 2018 at 2.1%, even as the mean moved up 13 basis points, but rose to 2.9% from 2.7% in 2019 and to 3.4% from 3.1% in 2020. The Fed now sees a total of eight 25bps hikes in the fed-funds rate through the end of 2020. That includes three increases this year, including yesterday’s move, three in 2019 and two in 2020, By the end of 2020 rates would end up near 3.4%.

The Fed feels they finally have the wind at their back

The interest rate increase was the least interesting part of the package delivered yesterday. Given the double-dose of fiscal stimulus delivered by Congress since December, FOMC members had little choice but to raise their expectations for economic growth and the number of rate hikes. Previously, only some included the fiscal stimulus in their projections.

On balance, the unchanged median projection for 2018 suggests a somewhat a dovish lean. The Fed does not look to be keen to get too far in front of the expected pickup in economic growth but is happy to make sure its outlook is realized before draining the punchbowl.

For one thing, the Fed raised its projection on where it expects its benchmark rate to end up in the long run. The central bank upped its long-run estimate to 2.9% from 2.8% and it’s likely to raise it even further, reversing a long process during which the Fed lowered its target. What’s more, seven of the 15 participants on the Fed’s policymaking arm favored four rate hikes in 2018, compared to just four members at the end of 2017. That number could grow if the US economy expands as fast and the unemployment rate falls as low as the Fed now predicts.

In its latest forecast, the Fed predicted the US economy would grow 2.7% this year and 2.4% next year. Similarly, the Fed forecast the jobless rate to fall to as low as 3.6% in 2019 from the current rate of 4%.

Oddly, the Fed kept its inflation forecast for the next two years the same even though it sees a stronger economy and falling unemployment rate. The central bank predicted inflation as measured by its preferred PCE gauge would average 1.9% in 2018 and moved above the 2.0% mark in 2019 and 2020. A modest overshoot of inflation following nearly a decade in which it has run under its target should not come as a terrible surprise. But, it speaks volumes to the bias of the current much changed FOMC not to push too hard or too soon against the rising fiscal tide.

Source: BIMB Securities Research - 22 Mar 2018