An increase in the Fed Funds rate at the March FOMC meeting was a forgone conclusion.
It was universally accepted by the investment community that the committee, led by newly minted Chairman of the Federal Reserve Jay Powell, would raise the upper bound of the Fed Funds rate from its previous level of 1.50 percent to the new level of 1.75 percent. The biggest unknown was whether the new chairman would continue the cautious approach of his predecessor, Janet Yellen, or choose a slightly more aggressive stance in removing the accommodative policies of the last ten years.
Fed Forecasts Remain Largely Consistent
The key pieces of the Fed’s post meeting communication were the statement and the committee’s projected path of policy interest rates (“dot” plot). The FOMC clearly recognized that the economy is picking up momentum and inflation remains within a comfortable range as reflected in their statement, “The economic outlook has strengthened in recent months…” The statement reiterated their expectation that price gains will stabilize around the Fed’s two percent target over the medium term. Finally, officials repeated previous language that they anticipate “further gradual adjustments in the stance of monetary policy.”
The changes to the economic forecasts released, along with the FOMC policy statement, show that a few Fed members have raised their forecasts for economic growth and lowered their forecasts for the civilian unemployment rate. Interestingly, there was very little change in the inflation forecasts.
The median forecast for 2018 GDP was revised up to 2.7 percent from 2.5 percent. The forecasts are now factoring in fiscal stimulus.
The long-run unemployment rate median estimate fell to 4.5 percent, however, in the near term Fed officials expected unemployment to fall to the mid-three percent range.
The median estimates for PCE inflation were relatively unchanged for headline and core.
The Fed “dots” reflected changes in the projected path of interest rates. The consensus forecasts continue to reflect an expectation for three rate hikes in 2018. Looking further out the curve, 2019 and 2020 are where the dots shifted the most. The 2018 average forecast was 2.13 percent which was unchanged from December. The 2019 and 2020 average rose to 2.9 percent and 3.4 percent, respectively. The long-run average rate expectation increased to 2.9 percent.
How Do the “Dots” Factor into Our Point-of-View?
The Fed Funds rate is now at 1.67 percent and inflation is running at roughly 1.8 percent (core) and 2.2 percent (headline). In our opinion, monetary policy continues to be easy and remains supportive of risk assets until the fed funds rate is at least 50 basis points higher than inflation. This implies that we still have three more 25 basis point rate hikes before we get to neutral monetary policy. Based on the current dot plots, the market predicts that this happens sometime next year. We are also focused on longer-term rates which have not moved much since the announcement and are currently at 2.9%. We believe that until the 10-year Treasury yield is at 3.5 percent equities remain attractive relative to bonds, supporting our continued constructive view on equities.