Three Rate Hikes Is Expected in 2018, But Two to Three Hikes in 2019

The US Federal Reserve (US Fed) decided to keep its federal funds rate (FFR) between 1.00-1.25% in the September FOMC meeting. On the economy, US Fed indicated that “the labor market has continued to strengthen and that economic activity has been rising moderately so far this year. Job gains have remained solid in recent months, and the unemployment rate has stayed low. Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters.” As a result, we believe the US Fed may likely raise its FFR by another 25 bps to 1.25-1.5% by end of this year.

Based on the US Fed dot plots analysis, the US Fed guided that it will likely increase its policy interest rate by another three times next year, by 25 basis points each. However, the latest assessment suggested only two to three rate hikes in 2019, lower than the earlier guidance of three to four rate hikes in 2019. Similarly, based on the dot plots analysis, the US Fed has also lowered its long-term average federal funds rate (FFR) from 3.0% to 2.75% currently. This supported the US Fed’s view that “economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”

At the same time, as widely anticipated, US Fed also announced that it will begin the Fed’s balance sheet normalisation program next month through the methods guided in this year’s June FOMC meeting. The US Fed will likely reduce its balance sheet by a cap of US$10bn per month in 4Q17, raising the reduction to a cap of US$20bn per month in 1Q18, a cap of US$30bn per month in 2Q18, a cap of US$40bn in 3Q18 and a cap of US$50bn in 4Q18. Following the series of reduction in 2018, the US Fed will then cut its balance sheet by a cap of US$50bn per month starting from 2019, until reaching a level supportive of economic growth.

For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be US$6 billion per month initially and will increase in steps of US$6 billion at threemonth intervals over 12 months until it reaches US$30 billion per month. For the holdings of agency debt and mortgage-backed securities, the cap will be $4 billion per month initially and will increase in steps of $4 billion at threemonth intervals over 12 months until it reaches $20 billion per month. Effectively, the actual reduction of the balance sheet will be much lower as compared to the cap set by the Fed, as the monthly maturity of the securities holding are mostly lower than the capping.

Going forward, with the US Fed starting to reduce the size of its balance sheet, we do not expect that the US Fed to be aggressive with its rate hike this year and next year.

Source: Affin Hwang Research - 21 Sept 2017