Fed View: Hawkish FOMC shift likely means four hikes in 2018 – We are adding another 25bp hike to our fed funds rate projections, and now expect the Fed to hike at each of the quarterly press conference meetings between now and June 2019. This equates to five further 25bp hikes, which will take the upper bound of the fed funds rate to 3.00%. Previously, we had expected the Fed to pause in its rate hike cycle at the December meeting, though we had flagged the risk of an additional hike.
We believe the market has underestimated the hawkish shift on the FOMC. While the median rate hike projection from the March meeting stayed at three hikes, and Powell’s press conference performance was somewhat dovish, the ‘dots’ showed a surprising shift among not only centrists, but also doves on the FOMC. This has been corroborated by recent hawkish-leaning commentary from more moderate doves, including Bostic, Harker, and Brainard (see here), which suggests that most FOMC members now see the risks to the outlook as being tilted to the upside, due to tax cuts and government spending increases.
With this change to our view, the risk to our forecast is no longer tilted towards more hikes, but is now balanced. On the downside, the risk is that wage growth fails to accelerate meaningfully from here, that financial conditions tighten significantly (if recent equity market weakness becomes disorderly), or that trade tensions escalate to the point that business confidence is affected. On the upside, the risk is that stronger wage growth passes through to inflation more rapidly, for instance if productivity growth falters. In a downside risk scenario, the Fed could pause in its rate hikes, while in an upside risk scenario the Fed would likely extend the rate hike cycle (hike for longer), or use hawkish communication/forward guidance to calm inflation expectations. We continue to think, however, that the risk of the Fed hiking at a quicker pace than once per quarter to be very low. (Bill Diviney)
Euro Macro: Is growth slowing? – A number of survey indicators for the eurozone have declined since the start of the year. The composite PMI, the Economic Sentiment Indicator as well as business confidence indicators in the main individual countries have dropped between December 2017 and March 2018. However, we think it is too soon to draw very strong conclusions from these declines. The indicators had overshot in the final months of 2017 and had become consistent with GDP growing at an annual rate of around 3.5-4%, which would be an unsustainably high level and well above our forecasts. Moreover, despite their declines, the indicators have remained well above their long-term average and their value at the start of 2017. Besides the confidence indicators, a number of hard economic data for January and February also disappointed. For instance, eurozone retail sales rose by only 0.1% mom in February after they fell by 0.3% in January. Germany’s industrial production dropped by 1.6% mom in February, following a meagre rise of 0.1% the month before. Unfortunately, these monthly series tends to be quite volatile. Indeed, weather conditions and shifts in winter holidays might have contributed to the weakness in the January-February data, making a rebound in March-April likely. Looking through the monthly volatility and survey indicators, we think that the domestic fundamentals behind growth in the eurozone have remained strong and should support ongoing robust growth in private consumption and fixed investment. Combined with the fact that our base case scenario for the global economy does not include a global trade war, but is based on the assumption of a negotiated settlement of the conflict between the US and China, we still remain comfortable with our scenario of ongoing growth at a rate above the trend. Please find our publication on the eurozone outlook here. (Aline Schuiling)