The Fed: still the market's flexible friend

  • Stocks rally and the dollar weakens as the Fed signals lower likelihood of further rate rises. 
  • Schroders forecasts one more rate rise this year, followed by a cut in 2020 as fiscal stimulus fades.

The US Federal Reserve (Fed) left interest rates unchanged, but signalled a more dovish stance at its January policy meeting. The central bank’s rate-setting committee indicated that it would be taking greater account of economic and financial conditions in setting interest rates going forward, saying it “will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate”. Previously it had said that gradual increases in the policy rate would be needed.

The Fed also made a separate statement where it said it would be prepared to alter the size and composition of its balance sheet “if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate”. Although Fed Chair Jerome Powell indicated that the central bank is still debating the long-run size of the balance sheet, it is clearly being seen as a policy tool if needed.

These statements, combined with observations on “muted inflation pressures”, mean the Fed has moved a long way since its last policy meeting in December. Such a move had been signalled by Powell and other members of the Federal Open Market Committee (FOMC) ahead of yesterday’s meeting but markets were still surprised by the dovish tone with risk assets rallying, the dollar weakening and the yield curve steepening. (A yield curve is a graph that plots the interest rates of bonds with equal credit quality but differing maturity dates).

Looking ahead, we still have one more rate rise from the Fed in our forecast, a 25 basis point hike in June this year. This will require a rebound in economic activity which we expect in the second quarter as the economy benefits from fiscal spending and lower oil prices. Further ahead we continue to see rates falling in 2020 as fiscal stimulus fades and the impact of past rate hikes slows growth.