New Fed chair Jerome Powell delivered the expected 25bp rate hike in the federal funds rate, showing that the Fed appears to be a lot more upbeat further down the line. Over the coming years, the growth/inflation mix is expected to be stronger, rate hikes faster and the median target rate at end-2020 31bp higher than three months ago. In terms of asset allocation, this implies a short duration bias, no significant USD weakening and a supportive environment for US risk assets.
The FOMC statement acknowledged that “the economic outlook has strengthened in recent months”. But Fed participants seem much more upbeat further down the line, as the outlook on growth, employment and inflation has improved. The median GDP projection has been revised upwards by 20bp in 2018 to 2.7% and by 30bp in 2019 to 2.4% on the back of fiscal stimulus, while unemployment was revised downwards one-tenth this year to 3.8% and down three-tenths next year to 3.6%. Interestingly, core inflation for both 2019 and 2020 was lifted by 10bp to 2.1%. Powell seemed rather relaxed on the forecasts, which “can change according to the economy”, implying that the Fed is willing to accept a slight inflation overshoot.
While the median FOMC projection continues to show three hikes for 2018, rate hikes are nevertheless set to accelerate. We note that 13 out of 15 members now expect at least three hikes this year vs. 10/16 three months ago. Further out, the median for 2019 is now at 2.9%, implying three additional rate hikes next year, an increase of one from December, while the 2020 median is now at 3.4%, up from 3.1% in December. The new Chair downplayed the dot plot as a tool and not a bible, saying the hike path is set to remain gradual, and that forecasts can change, depending on the economy.
The new Powell Fed wants to let the economy play out. As long as there is no impression from the data that inflation is about to accelerate significantly, interest rate hikes will remain gradual. The key take-away is a tightening Fed for several quarters, putting a barrier to USD depreciation and implying that bond yields should resume their uptrend. The Fed has confirmed that the overall backdrop remains supportive of US risk assets going forward.