The Fed has hiked its benchmark interest rate for the fourth time this year, raising the target range to between 2.25 and 2.50%. By contrast, the interest rate on excess reserves (IOER) was increased by just 20 basis points to 2.40%. Most market participants had actually expected the fed funds rate hike, even though implicit fed funds futures had only recently signalled a probability of just under 70% for a fed funds rate hike this year. The Fed’s statement published immediately after the interest rate decision reflects not only a slightly more cautious Fed attitude to global risks, but also a shift in expectations as to whether the Fed will raise key interest rates less sharply in the coming year than previously expected. For 2019, the median expectation is for only two rather than three rate hikes. In the run-up to yesterday’s meeting, particularly the Fed governors‘ ideas on the future direction of monetary policy comprised one of the most important topics of discussion in financial markets. Fed Chairman Jerome Powell stressed that further interest rate hikes would depend on upcoming data releases. Although yesterday’s interest rate decision thereby underpinned the central bankers‘ more cautious tone, US equity markets initially reacted with significant losses. The yield on 10-year US Treasuries dropped by around six basis points following the Fed’s decision. Obviously, many market participants had expected the Fed to clearly reject further interest rate hikes.
In particular, the Fed Chairman gave three reasons for the Fed’s somewhat more cautious stance. Firstly, he cited global uncertainties that had risen over recent months. At the same time, he noted that global growth had cooled, with the economic growth momentum in some important trade regions having diminished in particular. As a final argument, he observed that financial market volatility had risen recently, which had also led to a deterioration in financing conditions. On the last point, however, Powell made it very clear the Fed was not looking at a single indicator, such as stock market performance, but rather at a range of different financial market metrics.
In summary, yesterday’s FOMC meeting adopted a slightly less aggressive stance than in the recent past. Many market participants, however, had already discounted the announcement that no further rate hikes would follow next year. Since we expect the economy to perform well overall in the first half of 2019, we believe the Fed is likely to continue raising key interest rates for the time being. After two rate hikes in the first half of the year, we then expect a pause in the rate hike cycle. The challenge for the FOMC will now be to manage expectations so that market participants understand the Fed’s overall view without falling prone to extreme scenarios. The Fed will have more scope to do this from next year, to the extent that every FOMC meeting is accompanied by a press conference.