US Fed Signals Two More Rate Hikes This Year

The US Federal Reserve (US Fed) decided to raise its federal funds rate (FFR) by 25bps to be in the range of 1.75-2.00% in the latest June FOMC meeting, as widely expected. This decision marks the second rate hike for the year after the March meeting. The US Fed painted a decent assessment on the US economy based on the healthy labour market as well as the recent increase in inflation. The June FOMC meeting’s statement guided that “job gains have been strong, on average, in recent months, and the unemployment rate has declined. Recent data suggest that growth of household spending has picked up, while business fixed investment has continued to grow strongly.” We believe the tone of the FOMC statement turned slightly hawkish, as the US labour market continued to improve, with the unemployment rate dropping to an 18-year low of 3.8%, while nonfarm payrolls rose by 223k in May.

On the inflation front, Fed noted that “on a 12-month basis, both overall inflation and inflation for items other than food and energy have moved close to 2%.” This may also be in reference to both headline and core inflation rates, which rose above the Fed’s target inflation of 2%, at 2.7% and 2.2% respectively in May, due mainly to the rise in energy prices as well as lower base in the corresponding period of last year. The Fed’s preferred inflation gauge, the core-personal consumption expenditure (PCE), was only slightly below the target of 1.8% yoy in April 2018.

Based on the current Fed’s assessment on the US economy, the latest dot plots, signals four rate hikes in 2018, revised from the three rate hikes guided earlier. Fed also guided that “further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2% objective over the medium term,” signalling that focus on inflationary pressure in the coming months.

In the latest FOMC Summary of Economic Projection, the US unemployment is projected to be at 3.6% this year (compared to the March’s projection of 3.8%) and will then improve further and trend lower to 3.5% in 2019 and 2020, while inflation is anticipated to remain above its target at 2.1% in 2018 (March’s projection of 1.9%) and will stay buoyant at 2.1% in 2019 and 2020. The Fed was also more optimistic about GDP growth for the coming years, real GDP is now projected to be 2.8% in 2018 compared its previous forecast of 2.7%, but will then slow to 2.4% in 2019 and 2.0% in 2020. Going forward, if the labour market continues to improve and tighten, this could also lead to faster inflation while faster economic growth this year will also support the case for at least one more rate hike this year spurred by the increase in government spending following the Bipartisan Budget Agreement as well as the tax cuts enacted last year. As a result, we believe the US Fed may likely raise its FFR by two more times in 2018 to 2.25-2.5% by end 4Q18.

Source: Affin Hwang Research - 14 Jun 2018