The Fed embarks on a steeper rate-hike path according to the “trial and error” principle

The Fed remained yesterday evening on the monetary-policy tack which it has been pursuing in recent months, raising the fed funds target range by 25 basis points. At the same time, the expectations for the rate-hike trajectory going forward were revised upwards: the new median forecast by FOMC members sees the Fed tightening monetary policy twice more over the remainder of the year. And for the coming year a total of three tightening steps can be expected. As a result, the Fed’s overall tenor has shifted in the direction of a slightly more restrictive monetary-policy stance. FOMC members’ individual projections for GDP growth reflect confidence about the future trend of cyclical momentum while their prediction for inflation is that the rate of change is destined to remain moderate at only marginally in excess of 2%. The verdict was reached unanimously.

By and large, the Federal Reserve has acted in accordance with our view that key rates will continue to be adjusted upwards in the direction of a neutral rate, although we were admittedly assuming previously that the Fed would adopt a more cautious course of action. Furthermore, the Fed has altered its forward guidance and implemented a technical adjustment on the key-rate front. The interest rate on excess reserves which the Fed pays to commercial banks that store cash at the central bank (IOER) will in future always be set no less than five basis points lower than the top of the target range for the fed funds rate. Last but not least Chairman Powell announced that a press conference is going to be held after every FOMC meeting, starting in January of next year.

The Fed’s focus is now unambiguously trained on providing US monetary authorities with greater flexibility regarding future monetary-policy action. If the number of press conferences doubles from next year onwards, there will be a corresponding rise in the number of options the Fed has to adjust key rates. The decision to remove forward guidance is likewise aimed at increasing the rate-setting committee’s room for manoeuvre. The Fed will now have greater monetary-policy leeway, although this gain could be at the expense of transparency and predictability. What is more, the future monetary-policy alignment appears to be increasingly espousing a “trial and error” strategy. The impression is forming that the Fed will probably raise key rates slowly and gradually over the coming months. While this process is unfolding, the FOMC will keep a close eye on the economic development when framing further decisions. The implication, in our opinion, is that the Fed’s future rate-hike trajectory is going to be significantly more dependent on fundamental data than was already the case in the past. This could, in turn, spawn higher volatility on financial markets.

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