Fed Closes Out 2018 with Fourth Rate Hike

The Federal Open Market Committee (FOMC) announced today that it is increasing the range on the federal funds rate to (2.25% - 2.50%) from (2.00% - 2.25%). This is the fourth and final hike in 2018 and the ninth since they began normalizing rates in 2015. However, the Fed notably reduced its interest rate projections, inflation expectations, and economic growth outlook for 2019. Details from the meeting follow.

Language Changes and Themes

  • The FOMC noted, “Economic activity has been rising at a strong rate.”
  • Citing threats from a softening global economy, the Fed’s outlook highlighted that risks “are roughly balanced.’’
  • The FOMC “will continue to monitor global economic and financial developments and assess their implications for the economic outlook.”
  • “The committee judges that some further gradual increases” in the Fed Funds rate will likely be needed.
  • The Fed reduced its rate hike estimates from three to two for 2019. This would put the projected neutral rate at 2.875%.

Recent Market Action

  • Interest rates have steadily dropped since reaching near term highs in early November. This change occurred despite several other factors pressuring rates higher, such as the Fed continuing to unwind its balance sheet, increased Treasury issuance, and bouts of foreign selling.
  • Quarter-to-date, 2-year and longer rates have fallen, resulting in a flatter yield curve relationship between the 2-year and 10-year part of the curve, with the largest decline occurring in the 5-year part of the yield curve.
  • Major equity indices have turned negative for the year.

Conclusion

The market fully expected this rate hike to occur but remains uncertain on the number of hikes in 2019. The Treasury market curve continued to flatten post-hike while stocks remain under pressure. Any future decision on rate hikes will continue to be data dependent. The Fed’s base case is to increase rate, culminating in a neutral federal funds rate ranging from 2.75% to 3.00%. In anticipation of further Fed tightening, LIM continues to position its clients’ portfolios with a duration profile shorter than their respective benchmarks. However, when interest rates do increase, LIM will look to tactically cover the portfolio underweight.

The composition of the Federal Reserve Board of Governors continues to evolve as Susan Bowman was officially confirmed. The Fed now has five board members with two open positions which need to be filled by the administration. President Trump previously nominated Marvin Goodfriend, whose nomination has been approved by the Senate Banking Committee but has yet to receive a full Senate vote. Also, Nellie Liang, who was nominated in September, has yet to receive a Senate hearing but should face little opposition.

The Fed continues to unwind its balance sheet of Treasuries and mortgages. Sales have topped out at $50 billion per month. In addition, any fiscal stimulus policy initiatives would require additional Treasury supply, which should also put upward pressure on rates. If growth is stronger than anticipated, expect the Fed to move more aggressively to increase rates. Conversely, if there is a shock to the system or a general slowdown in global growth, expect the Fed to delay future rate hikes until the markets normalize. On the inflation front, we are trying to ascertain the Fed’s level of comfort in allowing inflation to run higher than its long-term 2% target. Technical forces continue to be very influential on the rate markets.

Disclosure

The opinions contained herein are those of Longfellow Investment Management Co., LLC (LIM) at time of publication and may vary as market conditions change. They are based on information obtained by LIM from sources deemed to be accurate and reliable. However, accuracy is not guaranteed. It is in the sole discretion of the reader whether to rely upon the opinions contained herein. The information provided does not constitute investment advice, is not a recommendation, offer or solicitation to buy or sell any securities, or to adopt any investment strategy and should not be relied upon as such. It does not take into account an individual investor’s particular investment objectives, strategies, tax status or investment horizon. There is no guarantee that any forecasts contained herein will come to pass.  Past performance is not an indication of future results. Investment involves the possible loss of principal.