Fixed income
28 Mar 2018 | By Mark Nash

Fed interest rate decision – March 2018

The US Federal Reserve (Fed) raises rates 25 basis points, but the changes from the Fed can be best described as ‘noise’ as slightly weaker data lets new chair, Jerome Powell, play it safe on his first outing.

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The US Federal Reserve (Fed) raises rates 25 basis points, but the changes from the Fed can be best described as ‘noise’ as slightly weaker data lets new chair, Jerome Powell, play it safe on his first outing.

The Fed is in no hurry to make any dramatic changes away from its gradual pace of hikes and that’s fully understandable. Since December, the outlook is marginally less positive, with the economic growth forecast less than Q4’s level, amid lower consumption. Wage data fell back in February after January’s anomalous surge, and big employment gains were offset by re-entrants to the labour market, suggesting capacity constraints weren’t quite as tight as expected. Finally, market pricing expectations of inflation still suggests the Fed will still undershoot its 2% target.

A relaxed Fed will support easy financial conditions, risk appetite and may hurt the US dollar in the near term.  However, it’s too early to call the end to market volatility seen in 2018. The US government’s fiscal deficit is set to grow to US$1tn on an almost permanent basis, representing a large source of spending for the US economy. This means interest rates do not need to be quite so low to encourage borrowing in the economy as the US government is borrowing more. Therefore, the Fed’s long run interest rate for the US economy needs to rise, and the precise timing of this is immaterial. Interest rates will rise across the curve, and be far more meaningful than an extra hike forecasted for this year or next.

Jerome Powell was able to play it safe in his first meeting without doing much. But with the US output gap closing, and fiscal policy ramping up, it’s a matter of time before he will need to make tougher decisions that really might upset his boss.

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