Fed sees hardly any notable boost to growth from fiscal policy

In line with market players’ expectations the Fed raised its key rates by 25 basis points after yesterday’s FOMC meeting. This was the third hike this year. The target range for the federal funds rate is now 1.25% to 1.50%. The decision was not unanimous. The President of the regional Federal Reserve Bank of Minneapolis, Neel Kashkari, as well as the President of the regional Federal Reserve Bank of Chicago, Charles Evans, spoke out against the decision. Both would have preferred to leave key rates unchanged. However, most market players had expected the interest rate increase. Against this background, the key rate hike was less interesting than how the individual monetary watchdogs assess the future interest rate path in their projections. In addition, the press conference probably attracted market players’ attention as this was probably Janet Yellen’s last interest rate announcement now that US President Trump has nominated Jerome Powell as the next Fed Chairman.

As far as the projections are concerned, the monetary watchdogs left their rate hike expectations for the next few years almost unchanged. In the run up to the meeting players in the financial markets had been speculating as to whether the Fed members might not adjust their interest rate expectations to the upside in light of the robust momentum of economic growth. Independently of the possibility of early tax cuts, the FOMC continues to assume there will be three interest-rate hikes. But despite the Fed’s assurances, the markets still appear to be sceptical with regard to the future pace of interest rate increases. Market players expect that the Fed will raise key rates just twice in the coming year. So the probability of a key rate of 2.0% or more towards the end of next year as inferred from the implied Fed funds futures is 61%. Changes to the projections affect the prospects for economic growth in particular, which are now viewed slightly more optimistically.

A major issue in the questions-and-answers session were the tax cuts promised by US President Trump. The Fed Chair admitted that the FOMC had discussed the tax breaks and their influence on the economy. However, these are unlikely to have any major overall impact on monetary policy in the next few months even though the pace of economic growth could be somewhat higher with a fiscal policy stimulus. Generally speaking Yellen was moderately optimistic with regard to the planned tax reform under US President Trump’s government. While some market players expect significant growth stimuli for the US economy, according to Yellen the US economy will find it hard to grow by three per cent in the next few years. But she did draw attention to the fact that there is heightened uncertainty surrounding the effects of the tax breaks and that the Fed will take account of the possible repercussions at the next FOMC meeting. At the same time, the monetary watchdogs revised up their interest-rate projections and growth outlook only moderately. This argues against the general expectation that fiscal policy will lead to significant changes in economic growth.

There were also questions about the equity market and Bitcoins. In this connection, Yellen emphasized that valuations in the equity markets are high, but said that this does not mean that the markets are overheated. The markets are also likely to reflect the good economic conditions with a low inflation rate. While Bitcoins are a highly-speculative form of investment, they play only a very subordinate role in payments and she does not see any acutely heightened risk for financial market stability.


Summary: No surprise – March meeting keenly awaited

Overall, the US monetary watchdogs had prepared the interest rate increase well and it solicited hardly any significant reactions. The yield curve has become steeper and ten-year US yields have fallen slightly. The markets are now probably keenly awaiting the meeting of the Federal Reserve’s Open Market Committee in March when the new Fed President Powell will give his first press conference. Although he has already been a member of the FOMC for a long time and is therefore likely to continue to conduct monetary policy without any major changes, he might wish to leave his own mark on policy.

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