Federal Reserve set to hike rates again in Powell’s first meeting

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21 March 2018

thomasdodds

The US Dollar bounced back against its major peers on Tuesday as investors eyed an expected interest rate hike from the Federal Reserve when it announces its latest policy decision at 18:00 UK time today.

A
s we have mentioned in our FOMC preview report, with financial markets currently fully pricing in a 25 basis point hike this evening the US Dollar will instead be driven mostly by the release of the Fed’s updated ‘dot plot’. We think that a number of factors since the December FOMC meeting, when the bank last released its quarterly economic projections, could mean that we see a modest upward revision to the bank’s interest rate forecasts. The passing of Donald Trump’s tax cuts in December are expected to lift growth in the US in 2018. We have also seen multi-decade low jobless claims, 16 year low unemployment and solid earnings growth that would suggest an overall tightening in labour market conditions that would warrant higher rates.

We expect the Fed to adopt a hawkish tilt in Jerome Powell’s first meeting as the new Chair. It will likely continue to emphasise the strong labour market and that inflation should stabilise around the 2% target. We see a good chance of an upward revision to the ‘dot plot’ to show an average of four interest rate hikes in 2018, with three or four pencilled in for 2019, a faster pace than the market is currently pricing in. An upward revision to the hike projections would take much of the market by surprise and, in our view, could lead to a fairly sharp upward move in the US Dollar this evening.

Pound recovers on impressive UK labour report

Sterling recovered ground against its major peers this morning after the latest UK labour report smashed expectations and continued to cement the case for a Bank of England interest rate hike in May. The unemployment rate unexpectedly fell to 4.3% in the three months to January, its joint lowest level since 1975. Equally encouragingly was the uptick in earnings growth, which saw wage growth including bonuses jump to 2.8% from 2.6%. This measure is now above inflation for the first time since real wage growth turned negative in late-2016.

The Pound had edged lower yesterday after the latest set of UK inflation data surprised to the downside. Inflation in the UK slipped to 2.7% in February, undershooting the 2.8% estimate and ending a run of five consecutive months above the 3% level. According to the ONS, the effects of the Brexit vote on the price of petrol and food have started to fade from the index.