March 2018 FOMC Increases Fed Funds Rate

March 21, 2018

Fed announces rate rise

The Federal Open Market Committee (FOMC) announced today that it is increasing the range on the federal funds rate to (1.50% - 1.75%) from (1.25% - 1.50%) with no dissents. This was the first rate hike in 2018 and the sixth since they began normalizing rates in 2015. Today's meeting was the first one led by the new Fed Chair Jerome Powell. Details from the meeting follow.

Language Changes and Themes

  • Economic activity has been rising at a moderate rate.
  • The labor market has continued to strengthen – job gains are strong and unemployment has remained low.
  • Inflation remains below the Fed’s 2% target, but is expected to rise in the coming months.
  • Fed estimates continue to show two more hikes this year, but more members are leaning to three hikes.
  • The Fed has signaled for a steeper path for rate increases in 2019-20.   

Market reaction

  • Rates across the entire yield curve have risen in anticipation of future rate hikes, the continued unwind of the Fed’s balance sheet, and the expectation of increased Treasury issuance. 
  • Short to intermediate rates have risen the most, resulting in a flatter yield curve relationship between the 10-year and 30-year part of the curve.
  • The longer (20+ year) portion of the yield curve has underperformed the short and intermediate maturities year-to-date on a total return basis, but returns have been negative across the Treasury curve.
  • Equities markets have experienced an uptick in volatility with major indices flat to slightly positive year-to-date. 

Conclusion

The rate hike was in line with market expectations. LIM continues to position its clients’ portfolios with a shorter duration profile relative to their benchmarks, in anticipation of further Fed tightening, which we believe will benefit those portfolios. Any future decision on rate hikes will continue to be data dependent. However, the Fed’s base case is to implement steady rate increases throughout the year, culminating in a range of 2.00% to 2.25% by the end of 2018.

The Federal Reserve leadership has transitioned from Yellen to Powell. As expected, the shift has produced minimal change in the Fed’s overall approach to monetary policy. The Fed will continue to increasingly unwind its balance sheet of Treasuries and mortgages, which could pressure rates higher in the second half of 2018. 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 that the Fed will move more aggressively to increase rates. Conversely, if there is a shock to the system which causes a flight to quality, expect the Fed to delay future rate hikes until the markets normalize. Technical forces have become very influential on the rate markets.

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.