Markets Wait to Learn Which Way the Fed Is Leaning

Data-focused Fed still dovish, but Brexit looms


Having already factored in an anticipated 25-basis-point rate hike, the markets are now eagerly awaiting the Fed’s forward guidance from its March meeting. Continued strength in the US economy could prompt shifts in the FOMC’s tone and “dot plots” – and foreshadow more rate rises on the horizon.

The markets are eagerly awaiting the Federal Open Market Committee’s next meeting on 20-21 March. We expect investor attention to focus more on the tone of the FOMC’s forward guidance than on the 25-basis-point rate hike that has already been priced into the markets.

At the meeting, the Federal Reserve is expected to revise its growth and inflation outlook for the US while also updating the much-scrutinized “dot plot”, which provides a snapshot of each FOMC member’s interest-rate forecasts.

The US economy has maintained its strong growth trend since the end of last year. Payroll data has accelerated, with more than 550,0001 new jobs created during the first two months of 2018. However, year-over-year wage rises have remained moderate, briefly spiking to 2.9 per cent in January before falling back to 2.6 per cent a month later1.

Continued strength in the US economy leads us to believe that a more hawkish stance from the Fed would be justified. As a result, we expect the central bank to upgrade its growth outlook and confirm its confidence in the underlying inflationary trend. This could nudge the dots marginally higher as FOMC members adjust their expected rate-hike paths.

At the same time, we expect the markets to be highly attentive to any dot dispersion, which would reflect diverging opinions within the Council of Governors. New Fed Chairman Jerome Powell gave a highly optimistic address before the House of Representatives and the Senate not long ago, so it will be very interesting to see how the Fed board as a whole views the current US economic situation.

Against this backdrop, investors may have to adjust their rate-hike cycle anticipations slightly higher. So far, the markets have priced in three increases in 2018 followed by at least one more during 2019. However, we expect three or four rate hikes during 2018, followed by two more in 2019. But even if the Fed’s market outlook is adjusted to match our forecasts, the impact on long-term rates should remain muted, as yields have already steepened significantly.

1 Source: Bloomberg, March 9, 2018

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