United States: Federal Reserve hikes rates in March; continues to signal two additional increases this year
At its 20–21 March monetary policy meeting, the Federal Reserve’s Open Market Committee (FOMC) unanimously decided to increase the target range for the federal funds rate to between 1.50% and 1.75%, up 25 basis points from the previous 1.25%–1.50% range. The move had been widely foreseen by market participants, whose attention was instead set on the path forward for interest rate actions. In this regard, the Federal Reserve sounded modestly more hawkish amid higher growth and inflation forecasts and lower unemployment rate estimates. Consequently, Committee members moved up their interest rate expectations for 2019 and 2020 but kept their 2018 estimate unchanged at three interest rate hikes.
The rate decision came as little surprise for market participants against a backdrop of a double dose of fiscal stimulus, a healthy macroeconomic picture and signs of mounting inflationary pressures. The communiqué that followed the monetary policy meeting reflected some of these upbeat assessments, stressing that “the economic outlook has strengthened in recent months”. Although these comments were partially offset by a less buoyant appraisal of incoming economic data, they are consistent with recent comments from Fed Chairman Jerome Powell that the headwinds holding back growth are turning into tailwinds.
Likewise, the press release brought forward the time horizon in which inflation is foreseen to move towards the 2.0% target, from “this year” in the January meeting to “in coming months”. Other elements were unchanged from the previous statement in January. It was noted that inflation would stabilize around the 2.0% target over the medium term, near-term risks appear “roughly balanced” and the Committee will continue “monitoring inflation developments closely”.
The Fed’s more upbeat assessment of the economy was made ever clearer in the Committee’s Summary of Economic Projections (SEP). The FOMC’s median projection for GDP growth for 2018 was upgraded to 2.7% from 2.5% in the December SEP, while the 2019 median forecast was up three-tenths of a percentage point to 2.4%. This likely accounted for stronger near-term momentum and the expected impact on growth of tax cuts and the bipartisan budget act. In addition, members lowered their projections for the unemployment rate, which is now seen at 3.6% in both 2019 and 2020. The long-term unemployment rate was also nudged down to 4.5% from 4.6%.
In line with upgraded GDP and unemployment rate forecasts, FOMC members upgraded their projections for inflation, albeit only slightly. The estimate for core PCE inflation in 2018 was held unchanged at 2.1%, but it was marginally upgraded to 2.1% from 2.0% for both 2019 and 2020. This reaffirms the Committee’s view that fiscal stimulus should have only a modest impact on inflation, a point reinforced by Chair Powell, who in the press conference highlighted a loose relationship between slack in the economy and inflation. Nonetheless, a moderate inflation overshoot is still significant since it denotes the FOMC’s more confident view on price pressures and paves the way for a more hawkish stance in upcoming meetings.
Against a backdrop of improving economic conditions and expectations of a mild inflation overshoot, several members of the Committee hinted to an upward shift in future interest rate increases. The Fed’s “dot plot”—which charts FOMC members’ expectations for future policy rates—saw a number of participants raising their forecasts and signaling a slight upward bias to increasing rates above long-term projections. The Committee now expects three interest rates in 2019 compared with the two previously forecast, and it now sees two interest rates in 2020 compared to just one projected in December.
On a slightly more dovish note, the median dot for 2018 was unchanged at three interest rate hikes this year, suggesting that the Federal Reserve is in no rush to front-load interest rate hikes until the economy accelerates this year. That said, the overall distribution of the 2018 dots moved higher, and one additional FOMC member shifting to four interest rate hikes this year would have tilted the balance. With some of the most dovish members of the Committee not voting this year, risks are mostly skewed to four interest rate increases being delivered in 2018, a scenario that FocusEconomics panelists are increasingly forecasting. The natural interest rate—the rate where monetary policy is neither contractionary nor expansionary—was nudged up to 2.9% from 2.8% in December.
All told, the Federal Reserve delivered what markets had expected and sounded marginally more hawkish, acknowledging the economy’s upbeat outlook and indicating a faster pace in the normalization of interest rates. FOMC members appear to be comfortable with a more expansionary fiscal stance, noting its only moderate impact on pricing behavior. The policy meeting also confirmed that the appointment of Jerome Powell as Chairman reflects continuity at the helm of the Federal Reserve. On this note, Powell explicitly said that the Federal Reserve will maintain unchanged its plan to unwind its balance sheet.