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FOMC hikes rates by 25 basis points, but what is the real takeaway?

The Federal Reserve has increased interest rates by 25 basis points to a Fed Funds target range of 1.75% to 2.00%. However this move has been entirely anticipated by the markets for a while and is not the market mover. How the FOMC deals with monetary policy in the rest of the year and 2019 is of more interest, as are its views on inflation going forward. In this regard there has been a hawkish shift. How are markets responding?

In the FOMC statement, there are a few changes, tidying up, but also slightly hawkish too. Here are the highlights:

  • Increases in interest rates consistent with “sustained expansion of economic activity” – this is a hawkish tilt.
  • Removes a whole section at the end of the statement that used to talk about rates likely to remain below, for some time, the longer term rate – this is a nod to the dots which in 2019 are expected to be above the longer term level (see “Dot Plots” below).

The graphic below is from ZeroHedge.


The “Dot Plots”

The FOMC dot plots give an indication of where the balance of the committee are sitting in their views on future rate moves. The last time we had a snapshot of this, in March, the committee was calling for the rate to be 2.00% to 2.25% by the year end (but only just), which meant that three rate hikes were expected this year. This would have been followed by another three next year to end 2019 at 2.75% to 3.00% and two more in 2020 before dropping back to around 3.0% in the long term.

However this time around, the moves in this June meeting have been pushed out by 25 basis points in the next couple of years. This is the main hawkish takeaway for the market today and instead of expecting three hikes as previously, the market will need to begin to price in expecting now four hikes in 2018. Once more there are three hikes projected for 2019 , also interestingly for next year, rates are expected to be above the long term level which is still 2.75% to 3.00%.

Here are the dots from March:

And now in this June meeting:


Economic Projections

There is a mild hawkish shift from the Fed on the economic projections. They have improved growth forecasts, lowered unemployment expectations and also increased inflation projections.

  • Growth is mildly upgraded by 0.1% in 2018
  • Unemployment has been further reduced by 0.2% this year and 0.1% next year.
  • Inflation is perhaps surprisingly only increased by 0.1% this year to 2.0% on core PCE. Given the rise in inflation data recently, perhaps this is a touch underwhelming.


Market moves

Have been reflective of a hawkish move with yields higher and the dollar gaining strength.

  • US 10yr yield +4bps to 2.99% (from 2.95% just prior to the announcement), with 2 year yields adding just over 4bps has added to the yield curve flattening
  • EUR/USD -45pips
  • USD/JPY +40pips
  • Gold -$3
  • S&P 500 -2 ticks

The interesting feature of this tightening is that the yield curve continues to flatten. The spreads across the curves continue to narrow, with the 2s/10s spread at 40 basis points and the 5s/30s spread at 25bps. This suggests that the Fed continues to tighten into a market not convinced of long term growth and the curve flattening could be a prelude to economic slowdown. Although at the moment, this is an outlier (US growth is holding up and inflation pressures is building further – see core CPI yesterday) this is still something that the doves on the FOMC will be watching and could begin to rein in some of the hawkish influences on the committee. This is not a concern yet (a properly inverted curve is unlikely to be seen for several months at this rate) but could increasingly take prominence as 2018 progresses and could also be a reason not to see 4 hikes.


Outlook for key trades

  • EUR/USD has dropped back once more to test the breakout support band $1.1710/$1.1750. A closing breach would be negative and begin to re-open $1.1640 key near term support area.
  • USD/JPY continues to climb and is nearing 111.00 now. This means the May high at 111.40 could now come under pressure.
  • GBP/USD continues to drop back although the near term support at $1.3290 remains intact for now.
  • Gold has dropped slightly but the $1289 near term support could now come under pressures

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At Hantec Markets Ltd we provide an execution only service. Any opinions expressed by analyst Richard Perry should not be construed as investment advice or an investment recommendation. This report does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. Forex and CFDs are leveraged products which can result in losses greater than your initial deposit. Therefore you should only speculate with money that you can afford to lose. Please ensure you fully understand the risks involved, seeking independent advice if necessary prior to entering into such transactions.