How much higher can rates go if growth does not pick up?
When the Fed announced its policy this week, there was already a consensus on the 25 basis point rate hike. The debate was more whether the Fed would guide in the direction of 3 rate hikes or 4 rate hikes in 2018.
It could be 3 instead of 4…
If you look at the rate trajectory projected by the Fed for 2020, it is talking about a peak level of 3.2%. That is nearly 1.50% higher than the range of 1.5-1.75%. With that kind of trajectory, it looks quite likely that the Fed may restrict itself to just 3 rate hikes in 2018. Another 2 rate hikes in this year will take the peak rate to 2.25% and then the Fed will have just 100 bps to cover in the next 2 years. That may be good news for global markets plus the commitment that the Fed will keep liquidity situation still in the accommodative phase. That will be positive for global liquidity.
Jobs and inflation…
Of the three factors that will determine the rate trajectory, jobs and inflation are the 2 key items. While unemployment will stay close to 4%, inflation is yet to get to 2%. However, the tariffs and the lag effect of the tax breaks should help in bringing the inflation above the 2% mark. From that point of view, the Fed will have reasons to sustain its drive towards 3.2% Fed rate target.
But where is the growth?
The big worry for the US economy will be the GDP growth. IMF has projected 2.7% for this year but even the Fed has admitted that actual GDP growth will taper to 2% by the end of 2020. That is hardly a scenario that will encourage aggressive rate hikes. While we may have 2 more rate hikes this year, the final trajectory depends on GDP growth. For now, the focus is on trade wars
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