With three hikes already completed this year, the Federal Open Market Committee (FOMC) is widely expected to raise short-term rates by another quarter point in December to lift the funds rate to a range of 2.25 – 2.5%, its highest point since early 2008.
While some might argue to the contrary, a strong case can be made that the Fed has done a solid job in gradually raising rates and reducing its balance sheet while remaining attentive to its dual mandate. At a jobless rate of 3.7%, the economy is at or below full employment, and inflation has edged back up to around 2%, in line with the Fed’s target.
The question, of course, is how much further — and how quickly — will the Fed go? According to central bank projections released in September, FOMC members hold a range of views about the near-term rate path from a low of 2.0-2.25 to 3.5-3.75% to end 2019. The central bank’s baseline forecast suggests another three hikes to take the funds rate to 3.0-3.25% to close out 2019.
Illustrating investor skepticism, the futures market is currently pricing in a 95% probability that the Fed will not raise rates as much as forecast, holding the benchmark rate at 3.0% or less. Those doubts largely stem from the recent slowdown in global growth, resurgent equity market volatility, persistent uncertainty around trade policy, and the apparent impact of prior rate hikes.
The Fed has been slowly reducing its balance sheet for the past 15 months. That, coupled with gradual, measured rate increases, appears to be having the desired effect. How much more is necessary to normalize policy and execute a soft landing for the economy? That is the question. The Fed has to carefully thread the needle between acting too slowly (and risking falling behind the curve on inflation) or being too aggressive and snuffing out growth altogether. It will be a tight line for policymakers to walk.
Will policymakers stick to their forecast, or will the slowing global economy and tighter financial conditions cause them to slow their pace or pause outright? The futures market thinks that the near-term upside in policy rates is limited, and we wouldn’t bet against that.
The bottom line:
The Fed’s bias toward tightening remains intact, but the pace of rate hikes appears poised to slow.
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