The relationship between the Fed outlook and the U.S.

This article is being uploaded on behalf of Maria Fenech, Investment Management Intern at Calamatta Cuschieri Investment Management Ltd.

Jerome Powell, the newly appointed Federal Reserve (Fed) Chairman, has already managed to trigger an intra-day upward tick in the U.S. Treasury 10-year following the relatively FOMC’s hawkish Meeting.

At the incumbent chairman’s first meeting, the Federal Reserve announced the anticipated interest rate hike. In fact, the Fed raised its benchmark overnight lending rate to a range between 1.50% and 1.75% last Wednesday. By doing so, the former signalled greater confidence in the economy and also increased the rate path, possibly in the coming meetings.

Regardless of the Fed's near-term outlook for just three rate increases, it is believed that the Fed will likely raise rates slightly faster and sum up to four rate hikes in total this year. Thus, indicating a stronger outlook for the U.S. economy.

Following the aforementioned announcement, US stocks dipped and the dollar tumbled – not moving significantly after that. It was only late during yesterday’s trading session that equities rebounded, on the back of the market’s expectations that the trade tariffs imposed on China will not impact the global economy as much as had been previously feared.

Powell moved on to recognise the fiscal policy which had a meaningful impact on the individual forecasts; it is not expected to improve trend growth, even though the tax incentives hearten investment and may help lift productivity. The median GDP forecast was lifted to 2.7% this year from 2.5% in December, and the 2019 forecast was raised to 2.4% from 2.1%.

The three-month y-o-y growth in average base earnings in January was 2.6%, the highest since late 2016. Moreover, the government has lifted the freeze on public sector pay and minimum wage is set to rise (almost 4.5%) next month.

In addition, officials are confident that the dual mandate will be reached since Powell has inherited good numbers – inflation data is expected to rise “in the coming months” and unemployment remains at 4.1%.

This year, from the labour front, Federal Reserve officials expected the unemployment rate to fall to 3.8% from the December projection of 3.9%. Further progress is projected in 2019, with the unemployment rate decreasing to 3.6%, where it is expected to remain in 2020 – signalling full employment at hand. The long-term rate edged lower to 4.5% from 4.6%.

Given the Fed’s abovementioned economic optimism, it kept its risk assessment balanced. This highlights the general impression that even though officials are confident that growth will strengthen, structural economic forces are not estimated to fluctuate much.

Although there is such positivity revolving around the Fed’s forecasts and statements, one cannot forget that the Fed has missed the inflation rate target since January 2012 and has misjudged the unemployment rate. Over the years, they have regularly predicted that the economy has reached full employment. Yet, the unemployment rate has repeatedly continued to decline.

Moreover, should one consider the economic concept known as the Phillips curve, which states that inflation and unemployment have a stable and inverse relationship – it is not the case in the U.S. This was affirmed by Yellen’s Press Conference in June of last year.

That said, there might be several other factors which one should consider. The savings rate might be placing an important role due to the recent upward tick in borrowing costs and also the fiscal stance being taken by the current administration. Undoubtedly, the recent imposed tariffs on China and the possible re-negotiation of the NAFTA agreement are other important factors that the Fed would need to consider prior tightening further its accommodative stance.