One more step

Please note this blog post was published over 12 months ago and so may not include the most up-to-date information, for example where regulation around investing has changed.

One more step

The decision by the Federal Reserve (Fed) yesterday to lift the target range by 0.25% panned out as the majority expected – see probability rate hike chart below. The step up in central bank interest rates, to a range of 2.25%-2.50%, represents the fourth hike in 2018 and the ninth since December 2015.

US economic growth trending above expectations, record breaking company earnings and unemployment at a 49-year low are reasons why the Fed think higher interest rates are necessary. When the US economy is expanding too quickly they are duty bound to control inflation to maintain sustainable growth into the future.

Interest Rate Probability

Source: Bloomberg, December 2018

However, Powell’s actions seem at odds with the present inflation backdrop. Oil prices have fallen significantly, and technology is seemingly still at work, pulling prices down globally.

Reflecting on the bigger, global picture President Trump issued the following Tweet ahead of the Federal Open Markets Committee (FOMC) meeting. While we would not agree with all aspects of the tweet he does make some valid points.

Source: Twitter, December 2018

In the accompanying statement Chairman Jerome Powell remained constructive on economic expansion but recognised troubling aspects for the global economy, in particular, the ongoing US-Sino trade tensions. As a result, the Fed shaved their predictions for rate hikes in 2019, from three to two. This tapering of expectations is demonstrated in the ‘dot plot’ chart below reflecting forward looking expectations in September (green) relative to December (purple).

Implied Fed Funds Target Rate

Source: Bloomberg, December 2018

Powell also said the Fed will move away from the continuous rate-hike road map, which has gained popularity, towards a data driven policy. In doing so they acknowledge the sensitivity of markets to Fed policy, and the fact that it is harder to predict with clarity how the landscape will shape up. The introduction of the $1.5 trillion fiscal stimulus this year, when the economy was already expanding nicely, has clearly exercised the Fed’s thinking. Meanwhile, Powell confirmed the reduction in the Fed’s balance sheet will continue, giving market participants more influence over price levels as the central bank stays away from buying bonds.

Powell’s decision to put up rates demonstrates he will not be intimidated by a Trump administration hell bent on growth. However, there is an equal danger in the other direction. If he is taking decisions merely to ‘stick to his guns’ rather than exercising independence of thought, he will pay a heavy price.

Trump does not take prisoners. Moreover, if the Fed honestly, but mistakenly, is too cautious in relation to inflation it will be found to have made a policy mistake. If inflation turns down quickly next year, as some say, a reversal in the Fed’s current higher interest rate policy may come sooner than expected. History will be the best judge.

With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. Past performance is not a guide to future performance. Tax rules can change at any time. This blog is not personal financial advice.

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