Market Comment: Fed in no hurry to step up pace of rate hikes

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In a widely anticipated move, the Federal Reserve yesterday lifted its benchmark rate by 0.25% to a range of 1.25%-1.50%. The US central bank stuck to its projection for three rate hikes in 2018. Sluggish inflation might be the reason why the Fed isn't eager to speed up its rate hike trajectory, says fixed income expert Chris Huijs.

As expected, the Federal Reserve raised its benchmark rate by 0.25%. In their newly issued forecasts, Fed board members appeared slightly more optimistic on economic growth in 2018, lifting their projections for US GDP growth to 2.5% from 2.1% previously. The new ‘Fed dot plot’ – a chart issued each quarter by the Fed, reflecting its policymakers’ assessments of appropriate future rate levels – indicated that Fed board members continue to project three rate hikes in 2018. Our own view is that the Fed will eventually deliver less rate increases than it is signalling (two rather than three) given that underlying inflationary pressures are likely to remain subdued.

As some analysts and investors had speculated that the ‘dot plot’ would indicate four rate hikes in 2018, bond markets yesterday night responded slightly relieved. Yields on US Treasuries, moving inversely to prices, declined by around 5 basis points across the curve. According to Chris Huijs, fixed income expert at ABN AMRO Private Banking, the outcome of the Fed meeting confirmed the central bank’s accommodative stance: “The Fed struck a somewhat dovish tone yesterday. The new dot plot didn’t signal willingness among Fed members to tighten monetary policy at a faster pace next year. In addition, two Fed board members surprisingly voted against yesterday’s rate hike. Both the dot plot and the dissent could point to increased worries about weak inflation.” 

For investors, persistently low rates imply that bond market conditions remain challenging. Huijs: “We continue to favour stocks over bonds. We also advocate a large cash position, because cash still offers higher returns than a large part of the bond market. Bear in mind that the era of negative bond yields isn’t over yet. Within bond markets, we see opportunities in US high-yield. Core government bonds could become attractive once yields moved higher again, but that could well be beyond next year.”

Do you want to read more?

Do you want to know more about our view on US interest rates and Fed policies? ABN AMRO Group Economics yesterday published a note on this topic: ‘Global Daily – Fed sticks to Fed rate hike view.’ Read it on the ABN AMRO Insights website or contact your advisor.