The March FOMC statement and update to Summary of Economic Projections (SEP) reveals a more hawkish bent to the Jerome Powell Federal Open Market Committee (FOMC) than the one Janet Yellen presided over in 2017, though the March statement was carefully calibrated not to upset the markets too much.
Not only did the FOMC raise the fed funds target rate range by a quarter percentage point at this meeting; but the committee also boosted its median forecasts for U.S. GDP growth for 2018 and 2019, lowered its median projected unemployment rate by 0.3 percentage points in 2019, and raised its core-PCE projections for 2019 and 2020 by a tenth of a percentage point above the 2.0% target.
While acknowledging the first quarter moderation in household spending and business fixed investment from the strong Q4 growth rate, the FOMC members obviously didn’t spend a lot of time dwelling on it; instead choosing to focus more on the improvement in the economic outlook, most likely due to the anticipation of faster economic growth over the next few years from tax cuts and additional government spending. The FOMC added the sentence, “The economic outlook has strengthened in recent months” in its March statement to underline the point.
As expected, the FOMC raised the fed funds target rate range another quarter percentage point today to between 1.50% and 1.75% and maintained its median forecast for three quarter-point rate hikes by the end of 2018 and 2019. However, looking at the distribution of the dots in the dot-plot, we see a clear migration to higher interest rate levels compared to the December dot-plot. Seven FOMC participants now expect four or more quarter-point rate hikes this year compared to eight FOMC participants that still anticipate three hikes this year. Back at the December FOMC meeting, only four participants saw four or more Fed rate hikes in 2018. If only one more FOMC participant migrates into the four-rate-hike camp at future meetings, the dot-plot median shifts to four hikes in 2018. Moreover, the FOMC median now sees two additional quarter-point rate hikes in 2020, up from just one quarter-point rate hike forecast for 2020 back in December.
Bottom line: The Jerome Powell FOMC is showing growing confidence in the economic outlook over the next two years, which raises the prospect of a slightly faster normalization of short-term interest rates and a higher terminal fed funds rate in this interest rate cycle. I think it also raises the risk that the FOMC tightens too aggressively, putting the economic expansion at risk.
I maintain my forecast for three quarter-point rate hikes in 2018, but acknowledge four rate hikes this year is a growing possibility, especially if economic growth accelerates as much as the models are projecting today. However, I remain skeptical that the pace of 2018 rate hikes will be sustainable into 2019 and 2020 without doing some serious damage to household spending, housing, and business investment. Consumers and businesses have been conditioned to record-low interest rates, and the seven additional rate hikes envisioned by the FOMC median over the next few years could prove to be too much. Especially since the FOMC, by shrinking its balance sheet, is already draining liquidity and tightening monetary policy.
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