FOMC Preview: March rate hike priced in. What’s next?

As the markets prepare for a 25 basis point rate hike, investors are likely to question the future path of rate hikes. Will the Fed hike interest rates three times this year or four?

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The FOMC will be holding its two day meeting which concludes today. Heading into the event, the futures markets have assigned a near 90% probability of a 25 basis point rate hike at today’s monetary policy meeting.

March rate hike 1
Fed funds rate probability – March 21, 2018 (Source: CMEgroup)

While this looks like a done deal, investors will be looking to the Fed’s statement, the dot plot and the press conference from Jerome Powell on the future path of interest rates.

While there was increased speculation in the markets during the month of February about the potential for the Fed to pencil an additional rate hike, the odds of that looks to have diminished for now.

For the moment, the futures markets are assigning three rate hikes as initially proposed at the December FOMC meeting.

This week’s meeting for a march rate hike comes with near 100% probability and odds have started to rise for the next rate hike to come in June, which is currently about 77%. Finally, the September FOMC meeting comes with a 53% probability of a rate while the odds for December stand at over 70%.

February payrolls puts market expectations back to three rate hikes this year

However, a lot could change if the U.S. economy starts to show tightening of the labor market. The nonfarm payrolls report for February came with a surprise of sorts and completely changed the perception compared to January’s report.

The main factor was wage growth which investors are looking at. While the initial report rise in wage growth for January spooked the markets that the Fed could hike rates more aggressively, those concerns were put to rest following the payrolls report for February.

Although the U.S. economy was seen adding jobs at a solid +300k pace, the fact that wage growth remained muted showed that the U.S. labor market still had room to absorb spare capacity. This meant that wage growth could continue to rise at a slow pace, underlining the Fed’s stance.

“We don’t see any strong evidence yet of a decisive move up in wages,” Fed Chairman Jerome Powell said in testimony to the Senate Banking Committee few weeks ago.

Wage growth was seen rising at a pace of 2.6% annually in February. This was a deceleration in the pace of wage growth which stood at a revised 2.8% compared to the initial reports of a 2.9% increase.

The wage growth data underlined the fact that the job gains were not accompanied by higher page but rather the higher demand came on account of higher supply. This was evident from the fact that the labor force participation rate also edged higher from 62.7% to 63% leading to the U.S. unemployment rate holding steady at 4.1%.

Still, some members of the FOMC continue to favor a faster pace of rate hikes. The Boston Fed President, Rosengren told reports a few weeks ago that the U.S. economy may require more than three quarter point rate hikes, calling it “regular but gradual” in order to keep the U.S. economy on a sustainable path.

According to Rosengren, the U.S. economy remained on a trajectory that could push inflation to the Fed’s 2% inflation target rate.

In conclusion, while the march rate hike is an almost done deal, any potential surprises from the FOMC members on the dot plot could once again evoke a similar reaction from the equity markets which posted a correction in mid-January this year.

For the moment, Fed officials are likely to keep a low key on the path of interest rate hikes and rather wait for more evidence about the economy for the first quarter which will be released in the coming months.


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