While the Federal Reserve is widely expected to hike interest rates at its upcoming monetary policy meeting, a host of event risks could impact the direction of further rate decisions.
Investors have long anticipated the Federal Reserve’s Open Market Committee (FOMC) will raise U.S. interest rates by an additional 25bps at the conclusion Wednesday to its two-day monetary policy meeting.
The action would mark the eighth time the Fed lifted rates since it committed to a zero-bound interest rate policy about a decade ago – soon after the titanic failure of Lehman Brothers shook the global financial system.
Indeed, since the end of 2016, the FOMC has been on a path towards gradually normalizing monetary policy, amid a general upswing in the economy, underscored by what the Fed has highlighted as “strong” job gains, as well as strengthened growth in household spending and business fixed investment.
At its previous meeting in early August, the FOMC kept the target range for the fed funds rate at 1.75-2%, however, the market generally expects another rate hike at its meeting in December, followed by additional hikes at least through the first half of next year. The expectations have been supported by rosy economic data, including a healthy labor market, with wage growth in August having risen for the first time in about eight months.
Jefferies chief financial economist Ward McCarthy recently noted he thinks the FOMC will raise the longer run fed funds rate – the so-called long run neutral rate – to 3% from 2.9%, which he said will likely be achieved by mid-year 2019.
Against this backdrop, McCarthy continued that “the next significant policy debate over the next twelve months will occur once neutrality has been achieved. At that point, doves will want to hold steady and hawks will want to continue to raise rates so long as the dual mandate objectives are still met.” He added that the “most logical compromise, in our opinion, would be for the FOMC to slow the pace of gradual rate hikes but continue to raise rates above the current estimate of longer run neutrality, nonetheless.”
The ‘most logical’ scenario McCarthy outlines would suggest three rate hikes in 2019, as well as in 2020.
Not always logical
While economic activity in the U.S. remains expansive, a myriad of potential event risks continues to derail the momentum, with the threat of yield curve inversion ever-present in the background – and from time-to-time surfacing to the fore.
Analysts have noted that when the yield curve inverts (when long-term rates fall below short-term rates), a recession typically ensues. This scenario has included the past two recessions, which occurred in 2001, as well as from 2007 to 2009.
