Don't get ahead of the Fed

Thought of the day

by Chief Investment Office 13 Jun 2018

The US Federal Reserve later today is widely expected to hike interest rates by 25bps for the second time this year, marking another step toward policy normalization. Upbeat economic indications, including US inflation data at a six-year high, unemployment at a near 50-year low, and an anticipated 2Q growth rebound have shifted the question from if the Fed will hike to how fast.

While we expect some interesting shifts in the way the Fed communicates, none is likely to unsettle the steady, gradual pace of rate hikes we forecast for this year:

  • Alongside a 25bps rate hike today, the Fed is likely to adjust its summary of economic projects (SEP), which could include shifting its median projection from three to four hikes this year. While some in the market may see this as a hawkish signal, we would view it as a mark-to-market move that matches our own estimate.
  • Other adjustments could include changes to the Fed’s official growth and unemployment forecasts to reflect stronger incoming data. Neither is likely enough to push up the Fed’s core PCE inflation prediction this year, and at any rate the Fed has communicated some comfort with a temporary overshoot in prices.
  • Fed minutes for May suggested a change to statement language, possibly dropping wording on keeping rates low for longer. But change in itself is not hawkish, since much of the text dates to much earlier times in the economic cycle, and the Fed has essentially achieved its mandate. We could also see more explicit recognition of downside risks, most notably on international trade relations.

After likely lifting rates today, the Fed will deliver two more 25bps hikes per remaining quarter this year, in our view, followed by another three hikes next year. We remain overweight 10-year US Treasuries and overweight global equities.

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