The Fed: Another rate hike, but what’s next?
Since December 2015, the Federal Reserve has implemented eight 0.25 percent rate hikes to the benchmark fed funds rate – upon which short-term debt is often based. Of these eight rate hikes, six have come in the last two years, including three so far in 2018. For you “Fed watchers”, a fourth rate hike is widely expected at the Fed’s December meeting on Wednesday.
For the past few years, the Fed has been quite adamant that a fairly aggressive interest rate hike agenda was needed to keep U.S. economic growth and inflation in check. Inflation is the year-over-year increase in prices for goods and services. In fact, even with Wednesday’s expected rate hike, the Fed still projects three more rate hikes next year and two more in 2020. But recent comments by the Fed seem to indicate a willingness to consider reducing its number of future rate hikes.
Through its manipulation of interest rates, the Fed seeks to promote economic growth and financial stability. As the Fed raises interest rates, it increases the cost of borrowing, inherently forcing consumers and businesses to reduce their spending. This, in effect, gradually slows the pace of economic growth, which prevents the economy from overheating and consumer prices from skyrocketing.
The Fed has long justified its rate hike agenda by pointing to the continued strength of U.S. economic data. Economic growth in the second and third quarters was a stellar 4.2 percent and 3.5 percent, respectively. For perspective, in the eight years since the Great Recession (2010-2017), the average annual growth rate for our economy was just 2.175 percent.
In 2018, the economy has been adding, on average, 206,000 new jobs per month. The national unemployment rate of 3.7 percent is the lowest since October 1969 and should further decline to just 3.5 percent in both 2019 and 2020. Annual wage growth is at 3.1 percent, the highest since April 2009.
Why then, given the veracity of the above economic data, would the Fed even consider reducing its projected interest rate hikes?
Yes, the U.S. economy is still expected to grow, but that pace of growth is expected to soften. According to the Fed, economic growth next year is projected at 2.5 percent and just 2 percent in 2020. Additionally, the U.S. economy is currently being strained by two external factors – America’s ongoing trade disputes, primarily with China, and a general weakening of the broader global economy.
President Trump, along with many Wall Street heavyweights, have argued that additional rate hikes place unnecessary strains on U.S. economic growth. In a way, the trade disputes and weakening global economy are already acting to prevent the economy from overheating and runaway inflation. Another rate hike in December, three more next year and two more in 2020 may simply be too much for the economy to handle and risk causing an economic recession.
So, what exactly should we expect from the Fed on Wednesday?
Currently, odds are around 80 percent the Fed will impose a 0.25 percent rate hike on Wednesday. The focus will not be on the rate hike itself, but on the Fed’s related commentary on future rate hike projections.
Wednesday’s Fed meeting has the potential to be a catalyst for the stock market. For Wall Street, the fewer the interest rate hikes, the fewer the perceived impediments to sustainable economic growth. Historically, the Fed isn’t prone to drastic changes in its rate hike agenda. It typically conveys changes to its monetary policy through subtle nuances in its wording and commentary.
This will be one of the more closely watched Fed meetings in quite some time. Not that I expect many of you to huddle around the office TV with a giant bowl of popcorn. Let’s be honest, it’s a Fed meeting and not the Rose Bowl. For consumers, fewer rate hikes would mean a lower cost of borrowing. For investors, it could be the shot in the arm the stock market has been looking for.
Mark M. Grywacheski, Investment Advisor
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Quad Cities Investment Group, LLC is a registered investment advisor with the U.S. Securities Exchange Commission.
