Fed’s caution disappoints markets

As broadly expected the FOMC lifted the Feds fund rate targets by 25bps to 1.50% - 1.75%. Fed members adjusted their forecast so that they reflect their more optimistic view of the US economy. The press statement also underwent changes, all positive. However, despite these efforts, the US dollar has been under heavy selling pressure since yesterday evening. The dollar index fell 89.3 following the announcement and kept losing ground on Thursday morning to reach 89.40 as investors seemed disappointed.

The Committee raised its growth forecast once again. The US economy should grow 2.7% in 2018, an increase from its forecast of 2.5% in December and 2.1% in September last year. On the employment front, the unemployment rate should end the year at 3.8% (3.9% in December and 4.1% in September). However, Fed members left roughly unchanged inflation projections. The Core PCE forecast for 2018 stays at 1.9% but was slightly increase from 2% to 2.1% for 2019. Finally, the Federal Funds rate forecast remains at 2.1% for year-end but was revised higher for 2019, from 2.7% to 2.9%. It means that the Fed should hike rates two more times this year and two times next year.

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Looking at the FX market, it seems that investors were expecting a much more aggressive path of tightening from the Federal Reserves. There were a lot of talking about a potential fourth rate hike this year but according to the dot-plots, it won’t happen. The Fed has started to unload its massive balance sheet just a few months ago. It will be done gradually and take many years, but still, there will consequences for borrowing costs. We believe that the cautiousness displayed by the Fed could be explained by the willingness to avoid disturbing financial markets further. Trump’s recent political decisions could only widen the budget gap. The US government is facing the threat of a shutdown every two weeks these days (I am exaggerating slightly) and the trade tariff situation is not helping to improve the market Sentiment. I believe that the Fed is waiting to get further clarity regarding the effects of the balance sheet unwinding and wants to avoid increase the burden on the government by limiting to some extent the increase of borrowing costs.