The Fed hiked rates on Wednesday, and we think that one more rise is likely this year, followed by three further ones in calendar year 2019. Will such rapid hiking cause problems elsewhere in the world and is this the only story in town?
1. U.S. Fed rate hike was widely expected, and we think the upwards trajectory will continue, despite concerns.
The 0.25% Fed rate rise was wholly expected by the Fed Funds futures market, but we think that actual rate hikes in the remainder of 2018-2019 may be more than current expectations (page 2). However, future rate hikes may be questioned, both inside and outside the Fed. The Fed Funds rate is likely to go above the neutral rate in 2019, creating economic and asset class headwinds, and there are also concerns that the current tightening trajectory could invert the yield curve – a possibility already referred to be several Fed members. But our base case remains that rate rises go ahead and that the U.S. economy continues to prosper – we forecast U.S. GDP growth of 2.9% in 2018 and 2.4% in 2019. The second reading of U.S. Q2 GDP released on Thursday morning after the Fed announcement revealed an annualized growth rate of 4.2% -the fastest since Q3 2014.
2. The global reaction to the rate rise (and the associated forecasts) was reassuringly limited.
The global market reaction to the Fed rate rise was limited. U.S. stocks fell in late afternoon Wednesday following the announcement, and Asian stocks opened slightly lower the morning after the announcement, but equity markets remained steady on Thursday. 10-year U.S. Treasury yields initially fell back, but remain well clear of 3%. USD strengthened slightly against the EUR. Perhaps the most dramatic moves were in Asia, where the Indonesian and Philippines central banks raised rates in response (page 5) – the former, in particular, is keen to pre-empt any currency fall-out. But, in general, emerging markets have taken the rate rise – and all the associated commentary and forecasts of future policy – in their stride, which should bode well for the future.
3. Europe remains focused instead on the twin problems of the Italian budget and Brexit.
Europe, meanwhile, remains focused on its own problems. European economic data suggests that a modest upswing is continuing, but Brexit and Italy continue to cast a long shadow. The ruling UK Conservative party starts its annual conference this Sunday and this should indicate whether Prime Minister May’s Chequers proposals are now dead and buried: it may not, however, show us the most likely path to Brexit from here. Italian budget targets published on Thursday night revealed a target deficit/GDP ratio of 2.4% for 2019, greater than expected. Markets have reacted negatively but not dramatically to the news: this situation could however get worse before it gets better (page 3).
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