Fed Cements Expectations for September Rate Hike

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The U.S. Federal Reserve held its two-day monetary policy meeting last week which concluded on Wednesday. The central bank left interest rates unchanged as widely expected but said that the U.S. economy was “strong” maintaining the course for a further rate hike in September.

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By noting that U.S. economic growth was rising strongly and that the labor market was continuing to strengthen, the central bank’s statement was seen as hawkish. Inflation has also remained near the Fed’s 2% inflation target rate, cementing expectations of two more rate hikes this year.

In its monetary policy statement, the FOMC said that “job gains have been strong, on average, in recent months, and the unemployment rate has stayed low. Household spending and business fixed investment have grown strongly.” The statement came amid a unanimous decision.

The central bank’s overnight lending rate currently sits in the range of 1.75% – 2.0%. It had previously signaled two more rate hikes over the remainder of the year, which was initially thought to be just three rate hikes. The Fed upgraded its assessment early in March as the U.S. economy was starting to show signs of growth.

The Probability for September and December Rate Hike Increases

Following last week’s Federal Reserve meeting, the fed funds rate showed an implied probability of a 91% chance of a rate hike in September. The odds for a December rate hiked increased to 71%.

The market reaction to the Fed’s statement released on Wednesday was mostly muted as the decision was widely expected. The U.S. dollar was seen trading a bit volatile but soon gathered momentum to close bullish on the day following the FOMC’s meeting.

With the Fed officials, including the Chairman, Jerome Powell noting that the U.S. economy was in a “really good place” officials pledged to move forward with gradual rate hikes. This is expected to raise the borrowing costs as the U.S. economy is on track for the second longest expansion in history.

The Fed’s statement from last Wednesday was also consistent with the views maintained by the Fed Chair Powell in his testimony to Congress, a few weeks ago.

U.S. Economy Advances Strongly in Q2, 2018

The U.S. economy was seen advancing at a pace of 4.1% in the second quarter of the year. This was the best performance seen in nearly four years. Growth was boosted by higher consumer spending and increased shipments abroad, ahead of the newly imposed tariffs from China in retaliation to the U.S. trade policies.

The Consumer Price Index as measured by the Personal Consumption Expenditure, the Fed’s preferred gauge of inflation also firmed, rising to 2%. The increase in inflation came nearly after six years of consistently missing the Fed’s inflation target rate. The most recent PCE data showed that inflation stood at 1.9% on an annualized basis. It hit 2% for the first time in March since December 2011.

Concerns Still Remain

Despite the overall optimism, there are still concerns that the monetary policy could be beaten off track. For one, the U.S. trade policies are expected to hit the U.S. hard. Following the imposition of trade tariffs, the third quarter GDP is expected to slow.

While the Trump administration has managed to flip-flop on its decisions, such as striking a deal with the EU, it has been particularly hard on China.

Meanwhile, President Trump has also started to comment on the Federal Reserve’s monetary policy as he said that higher interest rates were not favorable for the U.S. Dollar. Breaking the tradition, President Trump had been very critical of the Federal Reserve.

For the moment, the U.S. economy looks to be on track and the Federal Reserve is set to hike rates once again in September. While there is optimism for a December rate hike, a lot of it would be dictated on how the U.S. economy weathers the trade policies.

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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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