As expected, the Federal Reserve raised rates by 25 basis points today. And at this point, the outlook for the remainder 2018 looks largely determined, with both 75% of Fed officials and the markets pricing in one more rate hike in December to make it four for the year. What remains to be seen – and the focus for many with today's release – is how policy will develop in 2019 and beyond.
The only substantive change in today's statement was the removal of a sentence noting the stance of monetary as "accommodative" and supportive of both the labor market and the Fed's 2% inflation target. The doves will focus on this deletion as a sign the Fed thinks monetary policy is already neutral, limiting the outlook for hikes in the year ahead. We disagree. Chair Jerome Powell made a point in his press conference that the language removal doesn't change their outlook for continued gradual rate hikes (and that even including today's hike the federal funds rate stands below the long run forecast level of all sixteen committee participants). The change is little more than an acknowledgement that both inflation and employment have reached or surpassed target levels, and further "support" isn't necessary.
Updates to the projection materials (the "dot plots") also reinforce the outlook for higher rates through 2019. As noted above, FOMC members believe that a fourth hike is appropriate before year-end, while the outlook for 2019 has a median forecast of three hikes (and the financial markets have odds on just two hikes next year). This is little changed from the June forecasts, despite upward revisions to GDP forecasts for both this year and next. Worth noting is that the Fed has raised GDP growth forecasts with each of the last four projection releases.
While we agree with the Fed's forecast of 3%+ real GDP growth in 2018, we also expect growth next year to be 3%+ as well, while the Fed is forecasting real growth of 2.5%. Paired with continued strength in employment and inflation at or above 2%, we continue to expect four 25 basis point rate hikes in 2019, just like we expect this year. And with nominal GDP growth - real growth plus inflation - above 4.5% at an annual rate over the past two years, monetary policy will still not be tight for years to come.
In short, the path towards higher rates remains on track at a steady pace. Thanks to policy changes ranging from tax cuts to regulatory relief and attractive depreciation schedules, the economy is humming along and the "data dependent" Fed has received overwhelming data to prove it.
Brian S. Wesbury, Chief Economist
Robert Stein, Dep. Chief Economist
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