Hawks, Doves and Jays: Takeaways From First Fed Rate Hike Under Jerome "Jay" Powell
In Jerome Powell’s first meeting as chair, the Federal Open Market Committee (FOMC) raised interest rates, marking its sixth hike for the expansion thus far. The decision itself wasn’t a surprise1—the U.S. Federal Reserve (the Fed) has declared mission accomplished2on the full employment component of its mandate, the global cycle has strengthened and inflation, while still running below the Fed’s 2% target, has shown some signs of firming in recent months. In the eyes of the FOMC, removing monetary policy support is just what the doctor ordered.
The bigger issues for markets coming into today’s meeting were:
- What, if anything, could be gleaned about Powell’s policy views and leadership style;
- The Fed’s guidance on the future path of interest rates (i.e., changes to the dot plot); and
- Insight into how seriously and when the Fed is considering revisions to its inflation target.
In this regard, today’s outcome was hawkish. The 10-year U.S. Treasury yield moved up to 2.92% following the announcement and is hovering near its highest levels since early 2014. Meanwhile, the S&P 500® Index has been volatile but, on net, appears to be tracking slightly lower. Our key takeaways are that:
- The Fed’s guidance on the future path of interest rates shifted up. Whereas in December, there was a strong consensus on the FOMC for three rate increases in 2018, the Committee now appears torn between a three- and four-hike pace. Its rate forecasts for 2019, 2020 and the longer run all moved higher today.
- Consistent with these changes, Chair Powell noted that “the economic outlook has strengthened in recent months.”
- More broadly, the Fed has now taken a tightening step at every quarterly press conference meeting dating back to December 2016 (fives hikes and the balance sheet normalization announcement). Historically, it has been common for the Fed to build a rhythm to its tightening cycles. After a slow start, it looks like gradual equates to roughly four tightenings per year in this expansion.
We continue to view a four-hike pace as the speed limit for the Fed in this cycle. They can deliver on this plan if everything keeps going right, but risks are skewed squarely to the downside. A significant escalation of Sino-American trade tensions is one important risk scenario to monitor in this regard.
With markets pricing a similar outcome—slightly more than three Fed hikes in 20183—we see the risks to long-dated U.S. Treasury allocations as being roughly balanced today. Our 12-month ahead forecast for the 10-year yield of 2.8% isn’t far from current levels.
For equities, the biggest question is when the Fed will take the punch bowl away. We’re not there yet, but based on the Fed’s policy guidance and our estimates of the neutral rate of interest, Fed policy could turn restrictive and a hindrance to growth in 2019. Coupled with expensive U.S. equity market valuations, that leaves us relatively cautious on U.S. shares.
Ultimately, however, with global growth broadening and relatively attractive valuations in non-U.S. markets, we still see compelling investment opportunities in multi-asset portfolios.
1 Source: http://projects.wsj.com/econforecast/#qa=20180301001
2 Source: https://www.federalreserve.gov/monetarypolicy/2018-02-mpr-summary.htm
3 Source: Thomson Reuters Datastream, Russell Investments calculations, as of March 21, 2018
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