The Strategist

The Fed is getting ready to tighten monetary policy

06/14/2018 - 15:49

On Wednesday, the US Fed predictably raised the key rate by 0.25 percentage points, bringing it to 1.75-2% per annum. The American regulator is more optimistic about the state of the economy in the country (primarily employment), noting that inflation is approaching the target of 2%. This may lead to a more rapid tightening of the Fed’s policy. Now, most of the members of the Federal Open Market Committee are waiting for four rate increases this year and three more in the next.

The US Federal Open Market Committee raised the key rate to 1.75-2% per annum following a two-day meeting, led by the new head of regulator Jerome Powell. This is the second rate increase since the beginning of the year (the first took place in March). In 2017, the rate was raised three times, by 0.75 percentage points in total. In September, the regulator also announced beginning of clearing its balance sheet, which accumulated assets worth $ 4.4 trillion as a result of quantitative easing programs (now the regulator sells securities for up to $ 20 billion a month).

In the statement, the Fed noted "significant pace" of improving the state of the US economy, separately indicating growth in the number of jobs, consumer activity and investment. The committee also pointed out that inflation (including without food and energy) is approaching the target of 2%. "Further increases in rates will reflect an improvement in the economy," the statement said.

The regulator refused its old phrase that the rate "will remain below normal for some time" (about 3%).
The inflation forecast for 2018 was raised from 1.9% to 2% (2.1% taking into account food and energy); unemployment expectations were reduced from 3.8% to 3.6%. The forecast for GDP growth has been raised from 2.7% to 2.8%. The point chart, which marks forecasts of the committee members, has shifted towards four rate increases this year (in March, many expected three increases). In 2019, the rate can be increased three more times - up to 3-3.25%.

The markets took into account the decision on the rate. This outcome of the meeting was indicated by the favorable macro-statistics  of the USA. In May, the unemployment rate turned out to be record low once again - 3.8% (less than the Fed’s benchmark). Indicators of inadequate use of the workforce are also at a minimum since 2006. In such a situation, the increase in wages remains only a matter of time, Fitch expects. Inflation of consumer spending, which is guided by the Fed, in March-April accelerated to 2% (1.8% less without food and fuel). The increase in capital investments in the first quarter of 2018 was the highest since the third quarter of 2014.

Experts differ in assessing how long the tightening cycle of monetary policy will be.

Fitch predicts three more rate hikes in this and next year, indicating that widening the fiscal deficit by 1.4% of GDP between 2017 and 2019 is unprecedented support for an economy that is already in the growth phase.

Capital Economics is also expecting three more rate hikes this year, but only two in the next. Already in mid-2019, the slowdown in the economy could limit the rate hike, and the yield of ten-year bonds after rising to 3.25% by the end of this year (now about 2.95%) may again fall to 2.5%, the center’s experts say.