The March FOMC Meeting
Financial market participants took the Fed policy meeting outcome as “dovish,” but the end result was a little more hawkish. The Fed’s revised economic projections weren’t much of a surprise, but they illustrate the thinking behind the expected monetary policy outlook. Of course, there are risks, notably a major misstep on trade policy. Gulp!
The Federal Open Market Committee raised the federal funds target by 25 basis points to 1.50-1.75%. The dots in the dot plot edged slightly higher, which likely reflected the fact that Janet Yellen is no longer one of the dots. While the median number of expected rate hikes for 2018 remained at three, most (12 of 15) Fed officials were evenly split between three and four.
Despite signs of moderation in the pace of growth in consumer spending and business investment at the start of this year, Fed officials expected strong GDP growth in the remainder of the year and into 2019. Growth is then expected to slow to trend as job gains move down to a sustainable pace.
For near-term growth to exceed the longer-term trend, the unemployment rate is expected to fall further. Implicitly, the Fed assumes a relatively flat Phillips curve. Fed officials expect inflation to move toward the Fed’s 2% goal in 2018 and slightly exceed it in 2019 and 2020. This moderate inflation outlook allows the Fed to be gradual in raising short-term interest rates.
The base scenario is for the Fed to continue raising short-term interest rates 25 bps per quarter. There is little chance that it will accelerate that pace, but a number of things could prompt the central bank to pause. An external event, such as the third quarter’s three major hurricanes, is one possibility. A breakdown in the international trading system is another.
In past years, the Fed looked to the LIBOR-OIS spread as an indicator of financial stress. However, the Fed made no reference to it following the LIBOR scandal of 2012. The spread has been widening and investors should keep an eye on it.
President Trump’s decision to impose tariffs on Chinese goods was not taken well by the financial markets. More importantly, Trump added that “this is the first of many,” suggesting that trade policy worries aren’t going to go away anytime soon.
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