US Fed Will be ‘patient’ in Determining Future Rate Hike Decisions

The US Federal Reserve (US Fed) decided to keep its federal funds rate (FFR) unchanged between 2.25-2.50% in the latest January FOMC meeting, as widely expected. On the economy, US Fed indicated that “labor market has continued to strengthen and that economic activity has been rising at a solid rate. Job gains have been strong, on average, in recent months, and the unemployment rate has remained low. Household spending has continued to grow strongly, while growth of business fixed investment has moderated from its rapid pace earlier last year.” Despite the positive wording on the economic outlook, Fed also guided that inflation expectation has moved lower in recent months.

In its latest statement, the US Fed noted that they will be ‘patient’ in determining the future interest rate path in light of global economic and financial developments as well as muted inflation pressures. Recall that the US consumer prices fell for the first time in nine months in December 2018 amid a plunge in the cost of gasoline. The core PCE, Fed’s favourite measure of inflation, was at 1.9% in December 2018, lower than the 2% level seen in September 2018.

We believe that the US Fed will remain data dependent in determining its future monetary policy path. However, we believe that the US Fed may not follow closely the earlier published dot plot analysis (following the December rate hike), with the possibility of raising policy rate less than three more times in 2019. As previously guided by Fed Chairman Jerome Powell that the central bank's current Fed Funds rate may be "just below" neutral, we expect the Fed will likely slow down on its rate hike cycle, possibly one hike and pause into 2019. The Fed’s statutory mandate of fostering maximum employment and price stability is now at a balance due to the strong labour force but weakening inflation expectation. Additionally, the risk of further economic slowdown coming from the global economic and financial development, particularly due to the trade conflict between the two major economies are likely to cause the Fed to be more cautious in deciding further rate hike.

Besides the main monetary policy statement on policy rate, the Fed also highlighted regarding the monetary policy implementation and balance sheet normalization. In the statement, the Fed revised its earlier guidance, in which, the Fed now could adjust the details of its balance sheet normalization programme in light of economic and financial developments. Additionally, the range of monetary policy will now include altering the size and composition of its balance sheet. Recall that the Fed is reducing its balance sheet by the maximum size of USD50bn per month, USD30bn from US Treasury securities and USD20bn from mortgage-backed securities

Source: Affin Hwang Research - 31 Jan 2019