Fed signals gradually rising rates

Thought of the day

by Chief Investment Office 22 Mar 2018

As expected, the Federal Reserve (Fed) raised rates by 25 basis points on 21 March, taking the target range for Federal Funds to 1.50–1.75%, and struck a more hawkish tone relative to December’s economic outlook.

But 10-year US Treasury yields and the USD both fell, as the new Fed Chair Jerome Powell was less hawkish than anticipated, and we see little reason to expect the Fed to increase its pace of tightening significantly.

  • The FOMC statement added the sentence, "The economic outlook has strengthened in recent months." This, in part, reflects the strong labor market, but the Fed also put some emphasis on the softer first quarter data.
  • Inflation is now seen as rising "in coming months" rather than "this year" which is in line with our own forecasts. But the Fed is prepared to tolerate a mild overshoot of inflation relative to its target; it sees core PCE inflation at 2.1% by the end of 2019.
  • Powell noted the range of views among FOMC participants, and that the outlook remains uncertain. Fed policy is not set in stone, and will be adjusted depending on economic developments. We expect him to continue the trend among recent Fed chairs to act as a consensus-builder rather than a one-man show.

In our view, the Fed remains on track to continue raising rates at a gradual pace. We expect one 25-basis-point rate hike each quarter through the rest of the year. Faster hikes are unlikely, unless inflation threatens to rise beyond 2.5%. Against a backdrop of strong economic conditions and rising corporate earnings, we do not see gradual rate hikes as obstructing further gains in equity markets.

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