The Federal Reserve Open Market Committee raised the fed funds target rate by 0.25% to a new level of 2.25-2.50%. This was widely anticipated, with a high futures market probability of this outcome beforehand. There were no committee dissents.
The formal statement was little altered from November, noting that economic activity remains strong, unemployment remained low, household spending has continued to grow, business fixed income has moderated, and inflation remains near the policy target. However, there was a tempering of language in terms of further rate hikes (including insertion of the word ‘some’) as well as a comment that the Fed ‘will continue to monitor global economic and financial developments’ for assessment in future policy actions. Overall, the updated economic output pointed to a base case of about two interest rate increases next year.
The issue as of late has been a pause in economic acceleration, with building fears that the peak in economic activity has been reached, and an eventual slowdown and recession being the next stop. However, it is possible this assumption may still prove premature. In keeping with changing data, what was once thought of as a done deal—a continuation of this same pace of rate hikes into 2019—is now looking far less certain. Initial estimates by a variety of economists of 2-4 hikes next year have fallen back to 1-2, in keeping with the Fed’s assumptions, with the caveat of policy activity remaining even more ‘data dependent’ than usual. Chair Jerome Powell’s comments during the last several weeks have confused markets a bit—with initial comments alluding to the current fed funds rate being ‘far below’ the ideal level, while more recent discussion pointed to the current rate being ‘just below’ ideal. Probabilities for future hikes are certainly dependent on this changing sentiment and communication posturing to a certain degree.
On the dashboard:
Economic growth: Reported economic growth for the third quarter in the mid-3’s was not assumed to be repeatable in future quarters, with estimates of fourth quarter growth now slated to be in the 2.5-3.0% range (which still could be above potential). Beyond GDP, there have been a variety of metrics that have showed varying degrees of possibly decelerating growth. Since there are other factors that serve to ‘tighten’ financial conditions, such as weaker equity prices, a strong U.S. dollar and wider credit spreads, which could do the job for the Fed to some degree—and could serve to stall the pace of rate hikes engineered directly by the Fed.
Inflation: Although inflation measures ticked higher year on the back of higher energy prices, a reversal of that trend in crude oil resulted in a deceleration in the most recent CPI release to 2.2% for both headline and core. Including the fluctuations driven by energy price impacts, inflation levels have continued to hover near the Federal Reserve’s target level. This would act as a neutral influence on Fed decisions, all else equal—with inflationary and deflationary risks roughly balanced.
Employment: The labor market continues to run at a multi-decade high level, with some wondering if conditions have peaked, as jobless claim and employment growth data have displayed spottiness in recent months. While there were some weather-based considerations, it could take time for job markets to sour, as participation from a broader universe of job seekers has improved.
Equity and credit markets have been on edge this quarter, bucking the often-occurring ‘Santa Rally’ tendency (resulting in December being one of the most positive equity months over the past century). The point of contention appears to be the transitional point of economic growth to deceleration, and eventually recession, although signs of the latter remain in the distance. Catalysts for recessions included overheating in certain segments, general financial imbalances or an ‘overdoing it’ by the Fed. Nothing on this list appears to be the case thus far. However, a variety of wildcards remain in the picture that could affect sentiment, including the ongoing U.S.-China trade spat or a ‘hard’ Brexit.