Interest Rate in USA

USA - Interest Rate

Federal Reserve makes dovish hike in pivotal December meeting; lowers 2019 projections for growth and interest rates

At its 18–19 December monetary policy meeting, the Federal Reserve’s Open Market Committee (FOMC) unanimously raised its target range for the federal funds rate by 25 basis points, to 2.25%–2.50%. The move was widely expected by market analysts and FocusEconomics Consensus Forecast participants.

The December FOMC meeting was the most important monetary policy event of the year, highly awaited and scrutinized by markets not so much for the actual rate increase but rather for the update of the Committee’s forecasts for growth, inflation, and future monetary policy decisions over the coming years. This is formally known as the FOMC’s Summary of Economic Projections or, more colloquially, as the Fed’s “dot plot”. While for most of 2018 the Fed did its best to clearly signal to markets it planned to continue on a steady pace of rate hikes over the medium-term—a communication strategy known as forward guidance—the December meeting marked the first time that the Fed unequivocally indicated it was moving away from this trajectory and towards a softer, more cautious and data-dependent pace of rate increases next year. The median projection of FOMC members for the Fed funds rate by the end of 2019 was lowered from 3.1% in September to 2.9% in December, indicating that members now expected on average two rate hikes next year instead of three. Projections for subsequent years were also consequently lowered to reflect one less hike in 2019.

This change in the Fed’s stance comes as economic growth looks poised to slow next year, weighed on by a global economic slowdown, the trade war with China and fading effects from tax cuts enacted in December 2017. In its communiqué, the Fed again noted that business fixed investment “has moderated from its rapid pace earlier in the year”, indicating that the boost provided by corporate tax cuts might have been short-lived, though it also acknowledged household spending remained strong. This was reflected in the FOMC’s median GDP forecast, which was downgraded from 2.5% to 2.3% for 2019. The December dot plot also saw a 0.1 percentage points (pp) downward revision to 2019 headline and 2019-2021 core PCE inflation projections, while conversely the unemployment rate forecast in 2020-2021 was revised upwards by 0.1 pp.

In this context, next year the Fed will have to carefully balance its goals of keeping inflation in check, avoiding stifling growth by over-tightening, while simultaneously preventing the build-up of financial imbalances in order to maintain financial stability. Indeed, in its first-ever Financial Stability Report issued on 28 November, the Fed notably flagged “historically high” levels of corporate debt (particularly in the high-yield, riskier segments of the bond market), combined with “deteriorating credit standards” and “elevated valuation pressures” as significant vulnerabilities that could destabilize the financial system. Furthermore, the report also warned that, in good part due to these elevated asset prices, an escalation of trade tensions could lead to a particularly large market fall, notably in equities, which appear especially overvalued.

According to Jan Hatzius and David Mericle, economists at Goldman Sachs:

“The two key reasons for the shift downward were the sharp tightening in financial conditions and the softer-than-expected inflation numbers since the September meeting. […] Powell had said in September that a “significant and lasting correction in financial markets”would be a potential trigger for tightening more slowly, and he acknowledged today that, “overall financial conditions have tightened”. […] In our view, the main lesson of today’s meeting is that a hike in March looks less likely. Powell’s comments on the tightening in financial conditions suggest to us that absent a major market reversal, most FOMC participants are likely to see the recent tightening as enough for now.”

United States Interest Rate Forecast

The U.S. Federal Reserve’s median interest rate projection for 2019 is 3.00%, indicating two more interest rate hikes between now and the end of 2019. Our panel expects the federal funds rate to end 2019 at 3.13%. For 2020, FocusEconomics panelists see the federal funds rate ending at 2.98%.