Upbeat Fed turns more hawkish on rates

As expected, the US Federal Reserve (Fed) tightened monetary policy, with a 25 basis point increase in the target range for the federal funds rate to 1.75% to 2%.

The meeting will be noted for an upbeat statement on the economy where GDP growth is seen as growing at a “solid" pace supported by a pick-up in consumer spending and strong growth in business investment.

The committee’s latest economic projections showed stronger growth, higher inflation and lower unemployment than in March. The “dot plot” of members interest rate expectations moved up to show a median expectation of two more quarter point rate hikes this year compared to one previously.

The dots suggest three rate hikes in 2019 and one in 2020. Compared to expectations before the meeting, this was a more hawkish outcome than most had anticipated, particularly given the rise in the dot plot for 2018.

The latest move means that our forecasts are in line with the Fed on interest rates for the rest of 2018, with hikes in September and December. However, we only see two hikes in 2019 and expect the central bank to pause once rates reach 3%.

In our view, the cumulative effect of higher interest rates and an ebbing of fiscal stimulus should be enough to cause the Fed to pause in its hiking cycle and take stock. We expect the economy to decelerate in the second half of 2019, such that 3% proves to be the peak.

In the meantime though, markets will have to absorb a greater near-term tightening of monetary policy as the Fed takes a step nearer normalisation.

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