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Investment outlook

The Fed’s December meeting: not done yet

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Key Points
  • On December 19, the Federal Reserve (Fed) raised its target benchmark interest rate, the fed funds rate, by 25 basis points (0.25%), to a target range of 2.25% to 2.50%. This is the fourth hike of 2018 and ninth of the current cycle.
  • The Fed’s economic outlook softened slightly from September, and expectations for further rate increases have moderated.
  • In its accompanying statement, the Fed maintained an upbeat view of the U.S. economy, and it made no mention of recent financial market volatility.
  • We still anticipate at least two more rate hikes in 2019, although a pause in the first quarter has become more likely.
  • Financial markets have been practically “begging” the Fed to adopt a more dovish tone and had anticipated the change in its interest rate outlook prior to the meeting.

What happened?

The Federal Open Market Committee (FOMC) — the group within the Federal Reserve that sets monetary policy — voted to raise its target fed funds interest rate by 25 basis points, to a range of 2.25% to 2.50%. The FOMC has hiked rates nine times since 2015 and four times in 2018 alone. The median FOMC member — as shown in the Fed’s summary of economic projections — now expects somewhat softer U.S. growth in 2019, while becoming less sure of the need to raise rates more than twice next year.
 
The maximum fed funds rate for the cycle — which the Fed estimated at its September meeting would reach 3.4% — is now expected to reach only 3.1%. This would place it just above the Fed’s 2.8% longer run (or “neutral”) rate, the level at which it would neither stimulate nor depress the U.S. economy.

Why does the Fed’s action matter?

Financial markets are clearly reflecting a less certain outlook for economic growth than they were back in September, with long-term interest rates and equity market valuations falling in tandem. By adopting a less hawkish posture — despite not sharing the market’s economic pessimism — the Fed is acknowledging that it no longer believes the economy will require tighter-than-normal monetary policy to avoid overheating next year.
 
In addition, as Powell’s comments made clear, future Fed policy will depend more on incoming data than any preset path. This will almost certainly create a state of structurally higher uncertainty with respect to monetary policy and, in turn, more market volatility.

Importantly, the Fed was careful not to materially downgrade its assessment of the broad U.S. economy. It’s true that market-based measures of recession risk, including wider corporate bond spreads and lower equity valuations, have been “flashing yellow.” But the Fed will be paying more attention to the strength of the labor market, improving business activity and the lingering effects of federal fiscal stimulus, all of which continue to point to “go” for growth in 2019.

What was the market reaction?

This month, for the first time in well over a year, the Fed’s rate decision was not a foregone conclusion. Moreover, there was considerable uncertainty about what the path of future rate hikes would look like in the updated projections. As such, markets appeared to interpret the statement and forecasts as mildly hawkish, at least compared to what had been expected.

Markets have pushed back against further Fed hikes throughout the fourth quarter. Fed funds futures, which traders use to place bets on future Fed monetary policy, still haven’t priced in a single full rate hike in 2019 and have begun to reflect some probability of rate cuts starting in 2020.

A pause in the quarterly pace of Fed tightening could come as soon as March.


What is our outlook?

We still think the U.S. economic outlook is brighter than current market pricing indicates, and that the Fed will have room to hike at least two more times next year. Wage growth has continued to accelerate — albeit gently — above 3%, potentially leading to hotter-than-desirable inflation and reduced corporate profits.

While the upside risks to inflation remain in balance with the downside risks to the labor market, a neutral monetary policy seems appropriate. For this reason, we expect more rate hikes than the market in 2019. However, a pause in the quarterly pace of tightening could come as soon as March, given the dual deadlines for Brexit and the U.S.-China trade deal around that time.
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Profille image of Dimitrios Stathopoulos
Dimitrios Stathopoulos
United States
Glossary
The Federal Open Market Committee (FOMC) holds eight regularly scheduled meetings per year to review economic and financial conditions, determine the appropriate stance of monetary policy and assess the risks to its long-run goals of price stability and sustainable economic growth.

A basis point is a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%.

Sources
Federal Reserve Statement, December 2018.

Bloomberg.

A word on risk
This material is for informational and educational purposes only and is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice or analysis. The analysis contained herein is based on the data available at the time of publication and the opinions of Nuveen Research. Information is current or relevant as of the date indicated and such information may become outdated or otherwise superseded at any time without notice. Certain information contained in this material is based upon third party sources, which we believe to be reliable, but are not guaranteed for accuracy or completeness. This analysis is based on numerous assumptions. Different assumptions could result in materially different outcomes.

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