Fed hikes rates amid stronger inflation, shifts from crisis-era stance

Roman Schwartz
June 15, 2018

The federal government drastically upgraded its forecasted 2018 economic outlook Wednesday, saying the USA economy was rising at a "solid" rate; an increase from its previous prediction of "moderate" growth.

After two rate hikes in 2018, investors are focusing on the Fed's updated projections for increases during its remaining meetings for the year.

It's a signal of how hot Fed officials think the job market is running, which in turn tells them how much inflation is brewing relative to their 2 percent target and how aggressively they need to raise rates to maintain an even keel.

- Fed funds price in an 81% chance of a 25-bps rate hike in September, and odds for December increased from 51% to 57% as Fed Chair Powell's press conference got under way. "The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation". While awaiting for Fed Chair to deliver his prepared remarks and to field questions from the financial press a report that the Trump administration is finalizing a list of Chinese goods to be subject to additional tariffs hit the U.S. dollar like a ton of bricks.

The FOMC said economic growth has been "rising at a solid rate", and upgrade from "moderate" in May.

The ECB, which presiding over negative official rates and its version of the Fed's "quantitative easing" - bond purchases that have seen it buy €2.5 trillion ($3.7 trillion) of government and corporate bonds in only three years -, isn't expected to raise rates or further reduce a program that peaked at €80 billion of assets purchases a month in 2016, and is now running at a monthly €30 billion.

Projections released after the Fed's two-day meeting in Washington show policymakers expect the U.S. economy will grow 2.8% this year, while unemployment falls to 3.6%. Likewise, they saw the median Fed funds rate at 3.1% at the end of 2019, up from 2.9% in March 2018.

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Fed policy makers now see US unemployment at 3.6 per cent in the fourth quarter, followed by 3.5 per cent in 2019 and 2020, based on median projections. After years in which the economy expanded at roughly a tepid 2 per cent annually, growth could top 3 per cent this year.

The reflection of increased fears about rising prices is likely to surprise markets, as most economists had not expected the Fed to give a clear sign that an additional rate increase was likely until later in the year. The USD gained as soon as the projections and the rate announcement were public, but there was a sudden retraction when the news of the Trump administration moving forward with tariffs on Chinese goods that could come as early as Friday.

That index now is at 2 per cent but other measures of consumer and producer prices have accelerated, pushed by rising fuel prices, as well as metals prices that could be the result of the steep import tariffs President Donald Trump imposed.

The Fed's pace of rate hikes for the rest of the year could end up reflecting a tug of war between a sturdy economy and the risks to growth, including from a potential trade war that could break out between the United States and such key trading partners as China, the European Union, Canada and Mexico.

Nor is the Fed obligated to hike rates just because it has publicly said it will do so. Both are still actively undertaking quantitative easing, a policy of creating new money to buy financial assets in an effort to boost economic activity.

The bank's preferred indicator of inflation, consumer spending figures, showed annual inflation rose 2% in April or 1.8% if energy and food were excluded.

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