Fed Rate Hike Mirrors Strength in U.S. Economy

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The U.S. Federal Reserve (Fed) announced its second interest rate hike of 2018 on Wednesday, raising it by 0.25% to 1.75% – 2.00%. This was widely anticipated and no surprise to investors.

More closely watched was the Fed’s guidance on future rate decisions: It set its year-end 2018 expectations to 2.25% – 2.50%, a 0.25% increase over what was previously expected. This pushed up its 2019 year-end target rate to 3.00% – 3.25%. The 2020 and long run median expectations remained unchanged. 

The Fed also forecast slightly higher GDP growth and lower unemployment rates than previously expected. It now forecasts core inflation to hit 2.00% by the end of 2018—a slight increase from the previous statement—while the 2019 and 2020 inflation outlook remained unchanged.

Investors react to hawkish signs

The markets initially read the announcement as hawkish, sending the U.S. dollar up, stocks down, U.S. Treasury yields higher, and flattening the yield curve.

However, Fed Chairman Jerome Powell reminded investors at a press conference that the statement should be interpreted as reflecting a strong economy and not an economy that is overheating. This reversed most of the initial market reaction, and most asset classes evened out by end of the day.

Aligns with our view on U.S. economic expansion

The Fed statement confirms our thesis of further economic expansion within the U.S., which supports equity prices in the U.S. and in global markets. 

No changes made to our portfolios

The Fed’s forecast continues to align with our view that equities are more attractive relative to fixed income in the current economic environment. We have not made any changes to client portfolios based on this announcement, as we remain tactically overweight U.S. equities and the U.S. dollar.

Our funds and pools are well calibrated to participate in further upside potential, while focused to manage risk in more volatile and uncertain markets.


U.S. Federal Reserve Announces Second Interest Rate Hike of the Year  

The U.S. Federal Reserve today announced its second interest rate hike of 2018, shifting the target range up by 0.25% to 1.75% – 2.00%, the highest in nearly a decade.

In a statement released this afternoon, the Fed focused on the key economic data that guided its decision-making, including:

  • Strong job gains combined with low unemployment, indicating a strengthening labour market.
  • A pick up in household spending as well as continued strong growth in business fixed investment.
  • Inflation holding in line with the Fed’s 2.00% goal on a 12-month basis, overall and for items other than food and energy.

Closing in on long term targets

While keeping its accommodative stance on its monetary policy, the Fed’s latest interest rate boost supports the slow and steady return to historically normal levels, and closes in on an aim to a desired “neutral” rate.

It stated the timing and size of future adjustments will be assessed by realized and expected economic conditions relative to its maximum employment objective and its symmetric 2.00% inflation objective.

Eyes on inflation

Fielding questions from the press following the announcement, Chairman Jerome Powell spoke about any inflationary impact of current U.S. trade tensions. “Right now, we don’t see that in the numbers at all. I would put it then as more of a risk,” he said.

Powell also acknowledged “transitory developments” such as a recent rise in oil prices, may fluctuate inflation rates up or down, but suggested overall indicators of longer-term inflation expectations are balanced.

After today’s Fed rate hike, U.S. markets dipped slightly while the U.S. dollar fell versus the Canadian dollar and most major currencies. U.S. Treasury yields were up, with bond prices moving in the opposite direction.

We’ll bring more in-depth analysis on the Fed decision and what it means for your portfolio in the next few days. Meanwhile, you can view the full statement here.

 

About the Author

Edward Golding

Edward Golding, CFA, MBA, is an Assistant Vice President with the Investment Management and Strategy team at MD Financial Management. He oversees the Canadian, Dividend and U.S. equity mutual funds and investment pools at the firm.

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