FOMC Preview – Investors prepared for another rate hike

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The Federal Reserve will be holding its two-day FOMC meeting on June 13 and 14. According to the various economic indicators and the Fed’s minutes from May, the futures and the swaps markets are pricing in a full 25 basis point rate hike this week.

The U.S. short term fed funds rates currently stand at 1.50% – 1.75%. The rate hike is expected to push the short term fed funds rates to 1.75% – 2.0%. The 30-day Fed funds futures chart below shows that the futures markets are inching closer to the 2.0% rate threshold.

fomc preview
30-Day Fed Funds futures – 1.75% – 2.0% (Source: Tradingview.com)

This week’s rate hike will be the second quarterly rate hike from the Federal Reserve. At the December 2017 monetary policy meeting, central bank officials had forecast that interest rates would rise three times during the year.

With still two quarters left for the year, the biggest question that investors face is whether the central bank would be able to squeeze in one more rate hike. This comes amid the prospects of inflation overshooting the Fed’s 2% inflation target rate as communicated during the May FOMC meeting.

Calling it “symmetric inflation” officials signaled that it would tolerate the overshoot of inflation which for its part has managed to soothe nerves that the Fed won’t be pursuing an aggressive monetary policy amid higher inflation. But this still doesn’t answer the question of, will the FOMC be able to hike for a fourth time this year?

Latest economic indicators suggest that growth has returned in the second quarter. The monthly payrolls report for May showed a solid growth with the U.S. economy adding 200k+ jobs and the U.S. unemployment rate falling to eighteen year lows of 3.8%.

Economists predict that the U.S. unemployment rate might fall even further to 3.2% in the court of the next one year. Wage growth has also been steady albeit rising at a slower pace. As of May, the U.S. wage growth was seen rising 2.7% on the year.

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The U.S. GDP for the first quarter showed a somewhat slower pace of growth at 2.2%. Still, this is within the average band of 2% – 3% GDP growth that is expected from the U.S. this year.

Inflation is also expected to get a boost, thanks to higher oil prices in the recent months.

Despite the strong fundamentals that justify the case for a rate hike, there is still a lot of uncertainty surrounding the global trade. Most importantly the trade wars between the U.S. and the rest of the world are set to continue.

The markets behaved cautiously when President Trump initially singled out China. However, following the early June deadline of the steel and aluminum tariffs being imposed on other trading partners of the U.S. including Canada, Mexico and the EU, the markets are expecting to see a rise in uncertainty.

The EU called the tariffs “foolish” and along with Canada challenged the U.S. decision at the World Trade Organization (WTO). All three countries have either vowed or are currently in plans to hit back at the U.S. by imposing tariffs on their own.

This is expected to slowly but surely escalate to the point of damaging trade relations with the U.S. Despite the various measures taken by the U.S. Government such as tax cuts on the corporate side, the threat of trade wars is likely to void the positive outcome of other fiscal measures undertaken.

The Federal Reserve is most likely to address this factor and continue to maintain its gradual approach to rate hike. In all probability, while the Fed is expected to hike rates at this week’s meeting, the central bank could stick to its initial forecast of three rate hikes for 2018, or just one more for the remainder of the year.

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