Fed goes ahead with fourth hike of 2018

The Federal Reserve implemented its fourth rate hike of 2018 today (December 19), pressing ahead with further tightening despite growing turbulence in markets.

The 25 basis point hike brings the target range for the federal funds rate to 2.25–2.5%. All members of the Federal Open Markets Committee voted in favour of the move.

Key macroeconomic indicators for the US continue to look broadly firm. Inflation was 2% in both September and October, a slight decline on earlier months, while unemployment was flat at 3.7%, its lowest level for several decades. Average hourly earnings were up 3.1% relative to a year ago in November.

In its statement, the FOMC said the labour market had “continued to strengthen” while economic activity has been rising “at a strong rate”.

However, there has been growing instability in markets. In a possible acknowledgement of a need to slow the pace of hikes, the FOMC inserted the word “some” into its statement. “The Committee judges that some further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity,” it said.

Fed tightening appeared to be a factor in the emerging market sell-off earlier this year, and recently markets in advanced economies have also been affected, as the Bank for International Settlements notes in its latest quarterly review.

One key indicator of deteriorating market sentiment is the yield curve, which, at least according to one measure, inverted earlier in December. The yield on two-year US government debt rose above that of five-year debt, which some view as an indicator a recession may be on the way.

However, five-year yields were approximately level with two-year yields in trading earlier today (December 19).

Fed chair Jerome Powell acknowledged the less favourable backdrop to the hike during the post-meeting press conference, saying that “some cross-currents have emerged”.

He highlighted a few signs of a “softening” in the outlook, including the fact that growth in other parts of the world has “moderated”, and tighter financial conditions.

The ‘dot plot’ of FOMC members’ rate expectations shows many participants in the meeting shifted downwards their expectations for rate hikes in 2019 and 2020.

Many FOMC members had expected there would need to be three hikes in 2019; now most expect there will only need to be two. However, the consensus for the longer run is still clustered around 3%, little changed since the last projections were published, in September.