Market jitters mount ahead of Fed decision

The Fed will raise rates on Wednesday, but the key question now is how much further the FOMC will go in tightening policy.

A rate hike on Wednesday will mean that the Federal Open Market Committee (FOMC) will have increased interest rates four times in 2018, as was widely expected. But this rise is essentially ‘old news’, and the focus of financial markets has moved on, looking instead at the outlook for next year.

Currently, market pricing does not even fully price one rate hike in for next year, as Jerome Powell’s recent speeches point towards a Federal Reserve (Fed) that is no longer adamant that rate hikes will come at every other meeting, as was the case in 2018.

There are reasons to be positive on the US economy. Unemployment is at a 49-year low, while growth remains solid. Both the recent manufacturing and non-manufacturing purchasing manager indices (PMIs) pointed towards a healthy expansion, and crucially wages are now at levels not seen since the financial crisis, rising 3% year-on-year (YoY).

But around the globe, things are looking less strong. PMIs from China and Europe point to further deterioration in the world economy, while trade wars and the Brexit process, plus Italian budget instability, continue to eat away at confidence. The Japanese, German and Italian economies all contracted during the third quarter (Q3) of 2018, a worrying sign. Throw in criticism from the president over monetary policy and the Fed will be more cautious about pushing on with its policy of raising rates.

It looks like the Fed is happy with policy at present, with a neutral rate now close at hand. But that is very different to restrictive monetary policy, at least in its traditional pre-crisis sense. Combined with the policy of quantitative tightening, monetary conditions continue to tighten, which should support the US dollar in the near term.

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