FOMC hikes by 25bps. Market reaction: “Meh”

As expected, the Federal Reserve has increased its Fed Funds rate by a further 25 basis points to a range of 2.00% to 2.25%. This move was entirely priced in by the market in the run up to today’s decision, so comes as no surprise at all. But what else in in the decision that is causing markets to move? We look at the changes to the statement, the dot plots which reflect the forward guidance for potential moves in the Fed’s tightening cycle in 2019 and economic projections.

The main issues for today is how the Fed factors in the increased global trade tensions and what the dot plots look like into 2019. The Fed continues to shy away from focusing on the impact of the tariffs dispute, whilst there were very little changes to the dots or projections.

Changes to the FOMC statement

The changes to the statement are very few and far between (see below).

FOMC statement Sept 2018

There is a very minor tweak with the removal of the section on the stance on monetary policy remaining “accommodative”. Pretty much that is it. There continues to be very little nod to the trade dispute. Perhaps this is a case of the Fed not wanting to delve into the murky world of Trump politics, but at some stage this is surely going to have to be noted.

Changes to the dot plots

In the June dots there was only a very marginal balance on the committee that was going for a fourth rate hike in 2018. This meant that there was still a degree of uncertainty, given that not all of those dots have a vote in 2018. However the September dots show now 12 of the 16 members expecting a fourth hike in 2018 (which means December will now be nailed on). Other than that there is little to really gleam from the dots – no changes to the average groupings of the dots anyway.

In June, the committee also previously showed maybe a further three hikes in 2019 (towards 3%) with maybe one more in 2020 before turning back towards the longer run level of 3%. This remains the case.

It is interesting to see that before today’s latest dots, according to Fed Funds futures (on CME Group FedWatch) the market was calling 79% probability for a fourth hike in 2018 but following the decisive shift in dots going for a December hike, the probability is up around 84% (and is likely to rise further. What is interesting is that the moves further out the curve, with expectations of a further hikes for 2019 actually dropping. There could be a curve flatting impact on this move.

Changes to the economic projections

Again, there is little to really get from the projections other than an upward shift in the 2018 GDP expectation to +3.1% (which would certainly please President Trump). However, seemingly as the tax cuts lose their efficacy, growth in 2019 and 2020 continues to subside.

A shade lower on PCE  inflation in 2019 but no change on core PCE suggests the Fed still sees little real problem from inflation. This is interesting, given that the imposition of tariffs should be inflationary further down the road. It is in keeping with the fact that the FOMC seems to be keeping its head down on the tariffs issue. This is likely to be an issue that builds possibly in 2019 though and they may need to take account of this.

The impact on financial markets

There has been very little reaction in the aftermath of this decision. Unless Jerome Powell starts talking about caution from the trade dispute, then this is going to be a very forgettable FOMC rate hike. The very initial move was for a slip of dollar weakness, but with yields a shade higher now, we see a mild gain forming on the dollar. However in the larger scheme of things this is a very minor move on markets. US equity markets seem to be taking this positively too.

  • US 10 year yield – up less than half a basis point
  • US 2 year yield – up less than half a basis point
  • EUR/USD – 10 to 15 pips lower
  • GBP/USD – 10 to 15 pips lower
  • USD/JPY – 5 pips higher
  • Gold – no move. The range of the past few weeks continues
  • S&P 500 – 7 ticks higher

The outlook

There has been little real move on markets in the wake of this rate hike. The Fed continues to tighten but did little to change expectations on the speed of tightening. The dollar expectations on monetary policy seem to fairly well set and it seems that the reaction to the trade dispute will be an over-riding driver of the greenback. Unless there is an overwhelming improvement (from where we are here) in the economic data, the dollar may struggle for traction.