FOMC: Investors brace for rate hike and forward guidance

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FOMC

The U.S. Federal Reserve will be concluding its two-day FOMC meeting on Wednesday this week. According to the futures markets, the 30-day Fed funds rate is expected to rise by 25 basis points, bringing the short term interest rates to 1.25% – 1.50%.

December’s rate hike, now almost a done deal, will be the second rate hike this year. The Fed had previously estimated three rate hikes this year at the start of the year.

The central bank is also expected to continue with its balance sheet normalization program that began in October. The pace of unwinding is also expected to increase starting January 2018.

 

FedWatch: Fed funds futures probability. Source: CMEGroup
FedWatch: Fed funds futures probability. Source: CMEGroup

 

The Fed started to tighten monetary policy in December 2016, lifting interest rates for the first time from historic lows of 0.25%. This came after the Fed lowered interest rates and launched its QE program in response to the 2008 global financial crisis.

The markets were doubtful of the December rate hike up to a certain point recently. However, with the third quarter GDP data posting an above 3% expansion for the second consecutive quarter, followed by the U.S. unemployment rate at a 17-year low of 4.1%, the expectations firmed up considerably.

Inflation growth still remains a concern among some of the Fed officials. However, the FOMC has remained optimistic that the tightening conditions in the labor market will eventually stoke higher prices.

Wage growth also remained a weak point in the latest payrolls report. Average hourly earnings rose 0.2% in the month in November. This brought the yearly wage growth to 2.5%, slightly higher from October’s 2.4%. Still, it was below forecasts of a 2.7% estimated increased in November.

Inflation in the U.S. remained sluggish. Despite a temporary boost from the hurricanes in August and September, consumer prices slipped back. The headline CPI was seen rising 2.4% on the year. However, the Fed’s preferred gauge of inflation – the core PCE price index, remained stubbornly stuck below 2%. At the last release, core PCE price index was at 1.7%.

Hawks in the FOMC maintain the case for gradual rate hikes on concerns that inflation could overshoot the 2% target rate. On the other hand, doves maintain that the current pace of sluggish inflation growth could pose risks amid higher interest rates.

This Wednesday’s FOMC meeting will also be one of the last meetings chaired by the Fed Chair, Janet Yellen. Yellen’s term ends in February 2018 and the Fed governor Jerome Powell is widely expected to be the next chairman of the Federal Reserve.

For the markets, the appointment of Powell is seen as a sign of continuity for the current Fed’s policies.

Investors are also hopeful that the tax reforms from President Trump will also eventually help to push inflation higher in the coming months.

Following the release of the FOMC statement, the Fed Chair, Janet Yellen will be holding a press conference as well. The staff economic projections will be released which will give the market insights into the Fed’s forecasts for the next quarter.

This will also include the dot plot which will see the Fed officials’ estimates on where interest rates could be in the year ahead. The markets are expecting to see the Fed signal at least three rate hikes next year. This could potentially mean that U.S. interest rates will rise to 2.25% by end of 2018.

However, inflation data will remain critical for the Fed’s policy. Furthermore, the rate hikes will be subject to other economic data such as the U.S. unemployment rate. With the labor market continuing to show a tightening in the pace of hiring, there is scope for the pace of hiring to eventually flatten.

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John has over 8 years of experience specializing in the currency markets, tracking the macroeconomic and geopolitical developments shaping the financial markets. John applies a mix of fundamental and technical analysis and has a special interest in inter-market analysis and global politics.

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John has over 8 years of experience specializing in the currency markets, tracking the macroeconomic and geopolitical developments shaping the financial markets. John applies a mix of fundamental and technical analysis and has a special interest in inter-market analysis and global politics.

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