Fed hikes rates, big changes announced. What’s next for USD?

Summary:

• Federal Reserve lifts interest rates for the seventh time since late 2015 as expected
• 4 hikes estimated in 2018, 3 hikes more in the following year
• Long-term rate forecast unchanged, a signal the yield curve could continue flattening 
• Inflation projections little changed despite yet lower jobless rate estimates, GDP seen a bit stronger

In line with expectations the Federal Reserve decided to pull the trigger hiking its federal funds rate by 25 bps to 1.75-2.00%, the US dollar jumped immediately, but the overall landscape does not seem to be so supportive of the greenback in the longer-term. In 2018 there are two more hikes projected (4 hikes in the whole year), and 3 more hikes in 2019 - this scenario was also anticipated. On the other hand, the long-run interest rate projection was left untouched (neither dot was moved) suggesting the Federal Reserve intends to continue lifting monetary conditions not seeing higher inflation expectations. It could lead to further flattening of the yield curve which should not be US dollar positive over time as USD yields-hedge adjusted might become less profitable for foreign investors. 

The Fed lifts 2018 and 2019 rate forecasts leaving a long-run rate projection unchanged. Source: Federal Reserve, XTB Research

On top of that, let’s look at inflation projections which were just little adjusted to the upside even as forecasts for the unemployment rate were slashed another time in a row implying the Fed still thinks the NAIRU might be somewhat lower (there could be some slack left in the labour market). In terms of GDP estimates we were offered an upside adjustment just for this year being in part an effect of the tax reform. Notice that this forecast could be burdened with downside risks once oil prices keep rising over the rest of the year (this topic is brought up by President Donald Trump from time to time). Other key points from the statement look as follows:

• risks to the economic outlook remain roughly balanced
• monetary policy remains accommodative 
• further, gradual rate rises are consistent with inflation closing 2%, and economic growth 
• labour market keeps strengthening
• IOER lifted by 20 bps (this is a rate on excess reserves), the discount rate lifted by 25 bps to 2.5% both effective since 14 June
• longer-term inflation gauges little changed
• a cap on treasuries roll-off to rise to $24 billion and $16 billion for mortgage-backed securities (MBS), in line with earlier plans
• vote was unanimous

The dot-lot suggests the federal funds rate could be already above its neutral level as soon as 2019. Source: Federal Reserve

During his press conference Jerome Powell informed that since 2019 a press conference will be held after every single meeting, but new projections will be updated on a quarterly basis. He described the recent inflation data as encouraging underlining there is still too soon to declare a victory though. Fed’s Chairman added that the latest spike in oil prices will likely push inflation above 2% over the oncoming months, but it should be temporary. One of the most important reference was that the Fed expects rates will achieve their neutral levels over the next year or so (notice that the dot-plot shows 2019 dots being placed already above long-run ones). He provided that the balance sheet reduction process is proceeding smoothly. Powell referred to trade tensions saying that as for now he does not see any impact in any data. In turn, he described slow wage growth as a puzzle suggesting that no one really knows what is the neutral rate of unemployment. 

The EURUSD lost a bit of ground immediately after the materials were released, but declines were not particularly substantial. The pair keeps hovering in the vicinity of a crucial demand area being placed a notch above a 1.17 handle, and if buyers managed to stay there, it could constitute an interesting point for a long position. Anyway, even as today’s statement sounds quite hawkish the long-terms does not look so rosy (the yield curve should continue flattening as the Federal Reserve gets closer to neutral rate levels) therefore we keep seeing any deeper pullbacks in the EURUSD as short-lived ones. Source: xStation5