Fed raises rates by 25 bps, 4th in 2018; dovish for 2019 but unemployment number hints inflationary tendencies

Impact: Neutral (India Capital Market)

Brief: In the current circumstance one must consider two fundamental changes. One, at 2.89%, the US 10 year GSec yields are now trending lower than their 2018 peak of over 3%. Two, the US LIBOR is rising beyond the level of 2.8% primarily because of Fed’s normalizing balance sheet as banks have comparatively lower liquidity than they had before.


The US FOMC decided to increase interest rates by 25 bps, taking the Fed Fund Range to 2.25 – 2.50%. The committee concluded the year with four rate hikes, including the one in December. Governor Powell was quick to point out that initially, the FOMC was looking at three rate hikes, which would have put the Fed Fund Range at 2.00-2.25%, but as the year progressed, there was a need for an additional hike as the economy came out to be stronger than expected. Inflation was forecasted to be 1.9% for FY18, a number that is slightly lower than the target 2%. The growth has been recorded at 3% for the entire year, stronger than most anticipated but lower than the September forecast by 10 bps. Unemployment rate, which is a critical parameter for the Fed – was recorded at 3.7% for the current year. While there has been no change in this department, one must consider the fact that the target range is 4% and anything lower means strong consumer demand and possible inflationary tendencies.

For the next year, the FOMC is forecasting a GDP growth 2.3% as on December 2018 – a number that is 20 bps lower than the September expectation. Given this deceleration of the economic momentum, the Fed has lowered its expectation pertaining to the recovery. Hence, for the forthcoming year, the committee expects to hike rates no more than two times in comparison to three expected earlier. This however comes with the unemployment rate coming at 3.5% in 2019 -  even stronger than the previous year. We reckon the committee will wait and watch until more data is available and things evolve in the macro economy.

In the current circumstance one must consider two fundamental changes. One, at 2.89%, the US 10 year GSec yields are now trending lower than their 2018 peak of over 3%. Two, the US LIBOR is rising beyond the level of 2.8% primarily because of Fed’s normalizing balance sheet as banks have comparatively lower liquidity than they had before. What this means for emerging markets like India is that flattening yield curve (because of rising rates and high demand for long term US debt) may not necessarily benefit their markets as liquidity is sucked out (under the reversal of Quantitative Easing). We therefore remain cautious regarding both exchange rate and foreign investments. Having said that, the evolving global situation pertaining to the political risk and the recovering US economy will hold the key. Numbers will therefore do the talking as we move forward.      


US major macro variables trend

Indicators (%age)

2013

2014

2015

2016

2017

2018

GDP growth

1.8

2.5

2.9

1.6

2.2

2.9

Inflation rate

1.5

1.6

0.1

1.3

2.1

2.4

Unemployment rate

7.4

6.2

5.3

4.9

4.4

3.8

Fed Fund range

0-0.25

0-0.25

0.25-0.50

0.50-0.75

1.25-1.50

2.25-2.50

Source: Federal Reserve, IMF, Acuité Research
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