Snapshot - Economic Views

Fearful markets disappointed by Fed policy stance

Market participants had expected a more dovish statement given recent volatility in risk assets

12/20/2018

Keith Wade

Keith Wade

Chief Economist & Strategist

  • Fed funds target range raised to 2.25 - 2.5%
  • Central bank trims expectations for hikes in 2019, from three to two moves
  • S&P 500 drops sharply, yield curve flattens
  • Markets adjusting to new normal monetary environment

As widely expected, the Federal Reserve (Fed) raised rates by 25 basis points to take the Fed funds target range to 2.25 - 2.5%. The statement indicated slightly less certainty about future rate rises with a change in wording from “expects” to “judges that some” gradual increases in the target range will be consistent with meeting the Federal Open Market Committee’s (FOMC) objectives.

There were changes to the “dot plot”, which shows FOMC members have trimmed their expectations for rate hikes in 2019 from three to two moves. This would leave the median at 2.875% for 2019 (previously 3.125%) and 3.125% for 2020 (previously 3.375%). There was a significant fall in the number of members expecting a further three hikes in 2019. The Fed’s economic projections did not change significantly, although the median growth forecast for 2019 was reduced from 2.5% to 2.3%.

Overall the Fed has become slightly more dovish in its forward guidance on the economy and interest rates. However markets did not react well with the S&P 500 dropping sharply while long dated bonds rallied and the yield curve flattened in the wake of the Fed statement. Such moves would be consistent with an increased concern that the Fed will make a policy error and overtighten in coming months. Clearly, market participants had expected a more dovish statement and were disappointed that Fed chair Powell did not seem to put much weight on recent volatility in risk assets. We have yet to see a Powell “put”.

Whilst we are concerned about the risks of a recession in the US, the economy is performing well with growth running at just under 3% in the current quarter, judging from recent data releases. Growth will cool next year, but should still be sufficient for rates to rise twice more to peak at 3% in June next year, a view in line with the Fed’s projections. As we have argued before, this is consistent with a normalisation of rates after the period of ultra loose policy. Markets are still adjusting to the new environment.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.