Global Daily – Fed to signal fewer rate hikes

by: Bill Diviney

FOMC Preview: Putting your money where your mouth is – The FOMC is widely expected to hike a further 25bp this Wednesday, taking the target range for the fed funds rate to 2.25-2.50%. The focus for markets will be on to what extent the FOMC follows through on the recent dovish communication shift, and lowers its projections for future rate hikes.

A fall in the dots, and a statement tweak
We expect a fall in the ‘dots’ to signal two further rate hikes in 2019 (down from three), but for 2020 to be unchanged at one rate hike. We also expect some tweaks to the statement, particularly regarding the need for ‘further gradual increases’ in rates, which was hinted at in the November minutes. We expect some qualifiers to be added to this statement to suggest we are approaching the end of the rate hike cycle (for instance, that further increases may yet be needed), but that the tightening bias will nonetheless remain. This would be consistent with the approach taken towards the end of the 2004-6 rate hike cycle (see table below).

A possible fall in r* estimates
It is also possible that we see a slight fall in the median estimate for the long run fed funds rate (r*, currently 3.0%) given the recent shift in emphasis in public commentary on the topic. In particular, Chair Powell’s emphasis that we are now ‘just below the broad range of estimates’ of neutral, and Atlanta Fed president Bostic’s assertion that we are within ‘shouting distance’ of neutral. While Chair Powell’s comment was vague enough that there might be no change in his own assessment, the balance of commentary from a range of officials does hint at some lowering in the median.

Another IOER adjustment
Finally, we expect the Fed to implement another technical adjustment to the IOER (interest on excess reserves rate), by raising it 20bp instead of 25bp as usual. As with the last move, this would be to better anchor the fed funds rate more firmly within the target range, as it has continued to trade quite close to the upper bound. Another move was flagged in the November FOMC minutes, where there was even discussion of contingency planning for an intermeeting move.

What we and the market expect
How are the FOMC’s expectations likely to compare with current market and consensus expectations? While market pricing for fed rate hikes has declined significantly – with just half an additional rate hike in 2019 now priced in by OIS forwards – consensus has shifted more slowly, with the latest Bloomberg survey (14 December) continuing to show an expectation of three further rate hikes over 2019-20 (though the timing has been pushed back somewhat). Following the recent shift dovish shift in Fed communication, we revised our already below-consensus forecast for rate hikes to just one hike in 2019, down from two previously (see also our US Outlook 2019 – Slowdown, not recession, 14 December 2018). (Bill Diviney)