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Analysts: Fed To Keep Hiking Rates In 2018 But How Much?

Kitco News

Editor's Note: View Kitco News' full 2018 outlook coverage

(Kitco News) - Financial markets are not expecting the U.S. Federal Reserve to hike interest rates as aggressively in 2018 as policymakers have suggested in their individual forecasts.

However, analysts say, this could change, particularly if inflation picks up.

In December, the Fed hiked by 25 basis points for the third time in 2017, pushing the federal funds rate to a range between 1.25% and 1.50%. The so-called dot-plot showed officials envision a repeat in the next year. But markets aren’t so sure.

“In terms of the Fed’s projections, they’re looking for possibly three rate hikes in 2018 based on the dot-plot,” said Pat O’Hare, chief market analyst with “The futures market now has only priced in the probability of two rate hikes.”

The U.S. economy and job market have been expanding for years now. The economy grew at a 3.3% pace in the third quarter, the most in three years, and the Fed sees 2.5% growth in 2018. U.S. nonfarm payrolls rose by 228,000 in November and monthly jobs growth has averaged 174,000 in 2018 after 187,000 a year ago.

Still, in their policy statement after the December meeting, Fed officials pointed out that inflation remains below their longer-term 2% objective. The core personal consumption expenditures rate – thought to be closely watched by the Fed -- was up 1.5% year-on-year in November. This has been short of the Fed’s 2% target since mid-2012.

“For our Fed view, we’re still at two hikes for next year,” said Brittany Baumann, macro strategist with TD Securities. “We are probably a bit more on the dovish side.”

TDS looks for Fed policymakers to be data dependent, particularly on inflation, when making decisions, she continued.

“In the face of fiscal stimulus, if we still have below-target inflation and no convincing move in the neutral rate, the Fed is going be cautious to go much above 2% policy rates,” Baumann said. “We think they continue hiking, but policy remains constrained once they get to the 2% level.”

Brown Brothers Harriman looks for either two or three Fed hikes over the next year, said Win Thin, global head of emerging markets with BBH. Some on Wall Street have suggested the Fed could hike up to four times in 2018, Thin noted. However, he added, this might be “slightly aggressive” although something that can’t necessarily be ruled out.

Any expansion of U.S. fiscal policy could make the Fed more confident about tightening, Thin said. The one factor that would make rate-hike forecasting easier would be a pick-up in inflation, since this would remove one of the concerns the Fed has voiced, observers said.

“The missing piece is higher inflation readings in the U.S.,” Thin said. Thus, should they occur, he continued, “that would cement market expectations of Fed tightening next year.”

O’Hare said he views three rate hikes as a “reasonable expectation” for the year ahead. Like others, he suggested higher inflation increases the probability of tightening.

“If anything, there is a greater upside risk in what the Fed does…versus the downside risk,” O’Hare said. “There are a lot of forecasts for three rate hikes, but there is some decent potential that they maybe end up doing more than three.

“Obviously, the incoming data – and specifically the inflation data – will be the driver of that action.”

If the Fed does end up hiking three times, O’Hare commented, the yield on 10-year Treasury yields could poke above 3%. This was at 2.467% late Tuesday. The market has not been above 3% since January 2015.

“If you’ve got sustained 3%-plus GDP growth in the United States, and that is joined with rising inflation, you should see 10-year notes with at least a three handle on it,” O’Hare said. “The U.S. economy is poised to maintain a good growth posture that’s been better than we’ve seen in recent years, when you’ve had GDP averaging year-on-year closer to 2%. We see in all likelihood a pickup…because you’ve got a lot of things working together.

“You’ve got global growth taking place. And now you’ve got passage of the tax bill….With consumers likely to see higher levels of disposable income, there is potential entering 2018…for a nice pickup in consumer-spending activity. And, of course, consumer spending is roughly 69% of GDP.”

Observers do not expect a meaningful change in Fed policy simply as a result of a new chair, Jerome Powell. He was picked by President Donald Trump to succeed outgoing Chair Janet Yellen.

“He will really continue the messaging from Yellen,” Baumann said, citing continued rate hikes but at a gradual pace, particularly while inflation remains subdued.

“The only risk really is that we get a more hawkish Fed with the other governors,” she said. “But even then, I think it will just build a case that the central bank keeps hiking but not becoming too aggressive.”

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