Is a Fed pause cause for concern?

Thought of the day

The dollar dropped 0.9% against the euro, and US 2-year yields fell 4.5 basis points after Federal Open Market Committee (FOMC) minutes released on 22 November showed concerns over weak inflation. 

Several FOMC participants want upcoming data to increase their confidence that inflation is heading toward the Fed’s target before they decide to hike. A few are concerned that further increases in fed funds, while inflation remains persistently below 2%, could “unduly depress” inflation expectations. 

But we believe that Fed remains on course to continue gradually raising rates: 

  • The minutes show that most FOMC members still believe that cyclical pressures from a tightening labor market will likely show through in higher inflation over the medium term. 
  • Many of them also believe that the US economy is already above full employment, and that the labor market will tighten further. 
  • Some members are concerned that waiting too long to remove monetary accommodation, or moving too slowly, could lead to increased risks to financial stability. 

We now believe that, after a December hike, the FOMC will wait until June to accumulate data. This potentially changes the timing of interest rate changes next year, but we still expect two hikes in 2018, which shouldn’t unsettle either US financials or the broader market. Financials benefit from rising rates but not a flattening yield curve, so the impact of a Fed pause is uncertain. But there are several positives for US financials – including solid economic growth, benign credit quality and the prospects for deregulation and tax cuts – and it remains a preferred sector.

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