The only way is up!

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.

The only way is up!

The Federal Open Market Committee (FOMC) decided after Wednesday’s meeting to raise interest rates by 0.25%. The US Federal Reserve’s (Fed) target range for the federal funds rate is now 1.75% – 2.00%. Interest rates in the US have now risen by 0.50% this year and by 1.75% since they started raising rates back in 2015.

Policy makers had been bullish around the state of the US economy, buoyed by stimulatory fiscal policy. The economy is getting a boost from $1.5trn worth of tax cuts and a $300m federal budget spending increase. Added to this is the improvement in the rate of job creation. Unemployment in the US is currently at 3.8%, the lowest since the 1960’s and well below the Fed’s 4.5% target rate.

Gross Domestic Product growth is predicted to come in at 2.8%, well above the Fed’s forecast 12 months ago. Inflationary pressures remain in check despite stimulatory fiscal policy.

Probability of Four US Interest Rate Hikes by the End of 2018

Source: Bloomberg, 14 June 2018

With a robust outlook for economic growth, inflation remaining under control and unemployment on a downward trend, officials have increased the number of interest rate rises they expect to occur in 2018 from 3 to 4. The Fed has also signalled that they expect 3 more interest rate hikes in the US next year bringing the fed funds 2019 target rate up to a range of 3.00% – 3.25%.


Dot Plots from March’s and June’s FOMC Meeting

Source: Federal Reserve, 14 June 2018

The dot plot graph above, used by the FOMC to signal each member’s outlook for the path of interest rates, indicates a more determined desire to raise rates.

If the dot plots prove accurate, financial conditions will tighten (while remaining relatively accommodative) in response to continued strong activity levels across the economy.

In terms of outlook, the Fed is trying to provide as much clarity as possible. They announced that they will hold a press conference after every meeting, rather than occasionally. We know from history that central banks are capable of upsetting markets when they spring surprises, hence this is a welcome move. There is a saying that the job of central bankers is to ‘take away the punchbowl just as the party gets going’.

For now, the picture in the US is one of economic growth continuing while inflation is held in check by the gentle tightening of monetary policy. The US central bank is shrinking its balance sheet after expanding it to sustain the economy in the post credit crisis years. On this basis, absent a major shock, there are strong grounds for believing that the current economic cycle can be prolonged.

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