The US Federal Reserve (Fed) raised its benchmark interest rates by a quarter of a percentage point, to a target range of 1.50-1.75%. Andrew Mulliner, Portfolio Manager within the Janus Henderson Fixed Income Investment Strategy Group (ISG), and Darrell Watters, Head of US Fundamental Fixed Income, share their thoughts.
Andrew Mulliner, Portfolio Manager within the ISG
The Federal Open Market Committee (FOMC, the rate setting arm of the Fed) raised rates as expected and which had been fully priced in by the market.
However, the focus of investor attention was away from the move in rates and firmly on Jerome Powell’s inaugural press conference as the new Fed chair, and the summary of economic projections (SEP) that the Fed issues on a quarterly basis, which includes the collective rate hike expectations of Fed members’ over the coming years (the dot plot).
Given the tax cuts and the expansionary fiscal stance of the US government announced over the past few months, it was perhaps unsurprising that the Fed upgraded all of its economic forecasts. The adjustments to the expected path of interest rates were more modest than some had expected, with no change in the median expectation of three rate hikes in 2018, a modest increase for 2019 and 2020 and very little change to the expected level of long run interest rates.
However, the median interest rate expectations do hide a pick-up in dispersion among different Fed members’ view of future rate hikes, which appear to be more hawkish than previous iterations. It was noteworthy that Fed Chair, Powell, in his press conference noted that the three year forecasts came with a high degree of uncertainty, which blunted perhaps the most hawkish interpretations of the changes made.
In all, the Fed delivered a hike and messaging that was fairly close to what the average market participant was expecting. Ammunition for the bond bears comes in the forms of the upgrades to the outlook and a drift higher in the dot plot, while bond bulls will have been pleased to see no change in the median rate expectation for this year (two more hikes for 2018 expected) and an acknowledgement of the high degree of uncertainty that long term forecasts carry.
As a result, markets were little changed in both bonds and FX following the press conference with all eyes on the evolution of economic and inflation data ahead.
Darrell Watters, Head of US Fundamental Fixed Income
As expected, the Fed raised its benchmark rate by 25 basis points on Wednesday. It was the first increase since Jerome Powell took over as Fed chairman this year, and the sixth quarter-point hike since the central bank began normalising monetary policy. The Fed’s target rate now ranges from 1.50% to 1.75%.
More notable, however, was a change in the Fed’s outlook for future rate increases. A growing number of Fed officials now say a total of four hikes may be needed in 2018, rather than the consensus estimate of three. In addition, the median estimate for the benchmark rate rose to 2.9% by the end of 2019 and 3.4% by the end of 2020, up from 2.7% and 3.1%, respectively, the last time the Fed met.
During the central bank’s post-meeting news conference, Mr Powell cited an improving economy and strong job market as reasons for the rate hike. He also said that the Fed’s estimates for future growth and unemployment had improved. Further, the outlook for core inflation also climbed — but only modestly, to an estimated 2.1% next year, up from 2.0% in earlier forecasts. Asked whether inflation could take off, Mr Powell said data did not suggest that “we’re on the cusp of an acceleration of inflation.” Markets seemed to agree, with Treasuries rallying after briefly selling off following the Fed’s announcement.
We believe the Fed’s outlook suggests the path to policy normalisation should continue to be measured. Although inflation is trending higher, we note that powerful forces such as an aging population and the digitalisation of the global economy should help keep prices in check. Also, the tightening labour market has yet to result in a sustained increase in wages, while economic growth could face headwinds such as trade barriers and the rising deficit. As such, our base case is for the Fed to make a total of three quarter-point hikes in 2018, and for the 10-year Treasury yield to end the year at 3% to 3.5%.
These are the individual managers’ views at the time of publication. The opinions expressed do not necessarily reflect the views of others at Janus Henderson.