by Noelle Corum, Associate Portfolio Manager, and James Ong, Senior Macro Strategist, Invesco Canada
The Federal Reserve (Fed) raised interest rates by a quarter of a percentage point as expected on Wednesday and signaled two more rate hikes for 2018. It also released its Summary of Economic Projections (SEP) for the next few years, which suggests that the Fed is optimistic regarding the future performance of the U.S. economy.
The median real GDP projection rose to 2.7% for 2018 and to 2.4% for 2019 (increases of 0.2% and 0.3%, respectively). Inflation expectations for 2018 and 2019 remained unchanged. Despite the pickup in this year’s growth projection, the number of projected rate hikes remained at two more for this year. Looking further out, the so-called “dot plot,” or interest rate projections, shifted higher for 2019, and the Fed’s longer-run federal funds rate projection rose from 2.8 to 2.9%.
Inflation does not appear to be a concern for the Fed
The decision to raise the federal funds rate was widely expected and priced into markets, so all eyes were on the Fed’s economic projections and its median estimate of the number of rate hikes for 2018. In this regard, the result was more dovish than expected. Although not our base case, some market participants had expected to see the 2018 dots move up to support three additional rate hikes this year. Also, despite firming inflation data in previous months, there were no near-term changes in the Fed’s inflation projections. Unemployment projections fell slightly, signaling that the assumed threshold for generating inflation is lower. Overall, the projections suggest that the Fed is not concerned about accelerating inflation that would force it to begin hiking aggressively.
This month’s meeting was notable because it included the first post-meeting press conference by new Fed Chairman Jerome Powell. Markets were watching closely to discern his policy views and direction. Powell’s statements suggested that the economy is expanding at a moderate pace, but that inflation, or lack thereof, allows room for the Fed to be gradual in its policy normalization. Further, his commentary suggested that he sees no imminent inflationary threat, stating in the press conference that there is little evidence to suggest that the U.S. is experiencing a persistent acceleration in inflation.
Invesco Fixed Income’s outlook
The outcome of this meeting is largely in line with our views. Although we expect inflation to be firm over the next two months, we expect it to slow to a pace that supports two additional rate hikes this year. Continued U.S. growth, along with expectations for a benign inflationary environment, should support a gradual tightening path for the Fed, in our view. Going forward, we believe a benign inflationary environment and gradual monetary policy normalization should be bearish for the U.S. dollar and supportive for risk assets like investment grade and high yield bonds.
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