FOMC preview: Third hike and unchanged dot signals – Danske Bank

Analysts at Danske Bank expect the Fed to hike the target range to 1.25-1.50% at today’s meeting and to continue signalling three hikes in 2018 and 2019.

Key Quotes

“We expect the Fed to raise the Fed funds target range to 1.25-1.50% at next week’s meeting, in line with market pricing and other analysts. As a rate hike is fully priced in, it is by itself not a market mover and focus is on the updated projections and Janet Yellen’s press conference for more information about the director for next year.” 

“Right now, it seems like the Fed is on autopilot although it has become slightly more concerned about the persistent low inflation. Hence, we do not expect any major changes to the ‘dots’ for next year, which are likely to continue signalling three hikes. We also believe the 2019 median dot to be unchanged at three additional hikes although this is more uncertain. Usually, the market reaction to changes to dots further out is more limited than changes to the near term. The projections for inflation, growth and unemployment are usually less important, which we expect to be broadly unchanged, except for unemployment, which will be revised down, as the current rate of 4.1% is what the FOMC thought would be the level by year-end 2018. We may see a further decline in the Fed’s NAIRU estimate, which is currently 4.6%.” 

“Another question for next year is whether we will see further downward revisions to the longer-run dot (which is the Fed’s median estimate of the natural rate). Yellen has indicated she believes monetary policy is not far from being neutral at the moment and that further hikes are dependent on an increase in the natural rate driven by higher trend growth. As we are not many hikes away from the current level of the longer-run dot of 2.75%, the theme about the end of the Fed’s hiking cycle becomes increasingly important. Right now, the markets are buying into the idea of further hikes next year (now almost two hikes are priced in) but markets expect the hiking cycle to end earlier than the Fed indicates currently.”

“Also, the Fed’s view on the tax reform may attract attention. So far, the Fed’s strategy has been to wait for the tax reform to pass Congress before taking it into account (although a few FOMC members have already) but Fed Chair Yellen is likely to be asked about it at the ensuing press conference.”

“Jerome Powell is going to stick to the current policy strategy but the FOMC will be less experienced next year, which may be a problem if the economy is hit by a shock.”

“We expect the US yield curve to flatten further next year, as the short end is pushed up by Fed hikes and the long run is held down by (among other things) a low R-star.”

“We see EUR/USD staying roughly within the 1.17-1.20 range ahead of year-end but still call for a higher EUR/USD next year.”