The Fed’s fourth 2018 rate hike: proof positive of my accelerated timetable warnings

We have had the night to digest the Fed rate hike and the accompanying changes in the summary of economic projections. As I wrote yesterday, the move to a fourth hike was balanced on a knife’s edge. In the last go round, it was 8 to 7 in favour of 3. This time it is 8 to 7 in favour of 4 hikes.

Below are just a few thoughts on where we are headed next.

Still moving toward my 25 basis point bogey

The thing that most interests me here is how markets react. And we have seen is a narrowing of interest rate spreads to below 40 basis points between 2- and the 10-year Treasuries. At the same time, the 10-year Treasury bond remains anchored below 3%, with all of the tightening feeding into the front end of the curve.

I have been saying that after this rate hike announcement, I expected the curve to flatten to 25 basis points between the 2- and the 10-year. We are now 14 basis points away from that outcome.

What would take us further is a ratcheting down of the unemployment rate. I have come to see this as the key variable which the Fed is watching regarding policy. And the Fed moved its year-end unemployment rate down to 3.6% yesterday from 3.8% the time before. If we get to 3.6% in September, for example, it would force the Fed to move down its year end projection yet again.

And that would set us up for more rate hikes in 2019 than currently anticipated by the market.

Every meeting is live

What’s interesting about this is that the Fed will hold a press conference after every FOMC meeting starting in 2019. That means every meeting is ‘live’. The Fed was seen as lothe to raise rates at an FOMC meeting that was not accompanied by a press conference. Now that they are moving to press conferences in every meeting, it means the Fed could hike rates at any time. This possibility alone could flatten the curve further as the data come in.

It also gives Jerome Powell more sway. He can drown out the voices of the Fed Presidents and other Fed Governors because he will be speaking eight times a year in an official capacity instead of four. And because I believe Powell is more hawkish than Yellen, this will tilt policy toward a greater tightening bias.

The vote was unanimous

Having said that, it’s important to note that even the doves were onboard with this interest rate hike. There were no dissents. And that’s significant given the pause that Minneapolis Fed President Neel Kashkari has had regarding raising rates. It will be interesting to see what Kashkari says about Fed policy in the coming weeks because he may well be the new man to watch regarding Fed policy, replacing Lael Brainard.

Quantitative tightening was not on the agenda

From what I can ascertain, reducing the Fed’s balance sheet wasn’t a big consideration here. Powell is focused on rate policy as the signal. At the same time, the double-barrelled approach to tightening gives the Fed scope to increase the pace at which it rolls off its balance sheet. Increasing the pace of quantitative tightening in lieu of raising rates would give the Fed the opportunity to test what impact this has on the slope of the yield curve. Non-voting FOMC member and St. Louis Fed President James Bullard is noted for wanting to shift some of the weight away from rate policy. Maybe his views will gain sway as we move to 25 or 15 basis points of flatness.

Full steam ahead

It’s all systems go now in the US economy. Even the ECB has now signalled it will end QE in December.I may post on this as well. But the point is: a synchronized global policy tightening is now back on. Watch for the Bank of Canada and the Bank of England to join the party.

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