Fed Raises Rates

September 26, 2018, by John Norris

This afternoon, the Federal Open Market Committee (FOMC), the monetary policy making arm of the Federal Reserve, raised the overnight lending target 0.25% (25 basis points) from 2.00% to 2.25%. This was as expected, as the futures market had been giving it a 100% probability for some time now. The only real question was: will the Fed give us any idea about the next move(s)?

As is usually the case, it did and it didn’t.

Not surprisingly, the Fed’s official statement gave it plenty of latitude to raise rates for as long as it feels necessary to throttle this massive inflation, which has been running at a feverish 2.7%, or thereabouts, over the last 12 months. As such, and this is where gets fun: on the one hand, we are still in a Fed tightening cycle and the US monetary authority is committed to keeping structural inflation in check. So, no changes there. However, and there is always however…

The Fed removed any mention/description of monetary policy being ‘accommodative,’ or any synonym or approximation of the word, and completely removed that particular sentence from the statement. As a result, the markets are treating this as the Fed believes it has moved into a more ‘neutral’ policy. Taking it a step further, the Fed is basically admitting we are at the END of the beginning of the tightening cycle, at the least. Although it has taken the Fed an extremely long time to get to this point, it does NOT mean the remainder of the cycle will take as long (on the calendar).

As such, future Fed moves will become increasingly more ‘data dependent,’ as opposed to what you might call a fait accompli. The next move WILL be another rate hike, make no bones about it. However, it doesn’t mean we will have another 200 basis points of tightening in the future. If you catch my drift.

So, what does all this mean in layman’s terms?

  • New Fed Funds overnight target rate is 2.25%
  • Prime will be 5.25%
  • The futures market puts a 0.0% chance of a rate hike in November
  • The futures market puts a 77.5% chance of a 0.25% hike at the December 19, 2018 meeting
  • The futures market puts a 50.0% chance of a rate hike at the March 20, 2019 meeting
  • The futures market puts a 74.0% chance of a rate hike at the June 19, 2019 meeting
  • Anything after that is a stab in the dark, in my opinion
  • The spread between the overnight rate and the 30-year US Treasury Bond is under 1.00%. The 20-year historical average is close to 2.20%
  • The markets think inflation is contained, with 5,10, and 30-year expectations all between 2.1-2.2%
  • Any future Fed rate hikes will accelerate the flattening of the yield curve

At the end of the day, the Fed raised the overnight rate as expected. Although the Fed indirectly admitted it has entered into a more ‘neutral’ monetary policy, we are likely much closer to the end of the cycle than the start of it.