Federal Reserve says it’s hiking rates four times this year

The U.S. Federal Reserve may have telegraphed a fourth interest rate hike this year, but markets did not quite get the message.

After the conclusion Wednesday of its two-day meeting, the Federal Open Market Committee, through the so-called dot plot of individual members’ expectations, indicated that it would increase rates two more times before 2018 ends.

That would come on top of the quarter-point rate increase the committee approved at the meeting, as well as one already enacted in March.

While the more aggressive tilt normally would trigger a corresponding move in the fed funds futures market, where contracts for the central bank’s benchmark rate are traded, the response was minimal.

As of Friday afternoon, traders were implying just a 55 percent chance of a fourth hike in December — a little better than a coin flip and just 10 percentage points or so above the chances before the meeting and the surprise dot-plot change.

There are multiple reasons why the market is not buying into a more hawkish Fed.

Primarily, they center on the belief that the central bank will have limited room to move considering the dovish position of many of its global counterparts. There also are fears that a Fed that is too hawkish could invert the curve on government bond yields and signal a recession.

“I was of the view that the Fed will and should only go twice. Based on the recent data, it looks like the third hike is hard to argue against,” said Joe LaVorgna, chief economist for the Americas at Natixis. “I just don’t see the Fed being able to go as much as they want given where the curve is and the dots are. If the Fed hikes four times this year, the curve is going to invert in December.”

“Maybe they ignore that, maybe it doesn’t mean anything, but that would trouble me,” he added.

The rate increase came as Fed officials gave the economy high marks, though it took just one member to move his or her dot higher on the chart to tilt the median toward another hike.

Chairman Jerome Powell said that while the Fed is “not ready to declare victory” on its price stability mandate, he added that growth looks strong and able to support the central bank’s continued march back toward normalization. The committee kept its benchmark rate anchored near zero for seven years until beginning to hike in December 2015. Wednesday’s move pushes the target range for the rate to 1.75 percent to 2 percent.

“The economy has strengthened so much since I’ve joined the Fed,” Powell told reporters at a post-meeting news conference. “Really, the decision you see today is another sign that the U.S. economy is in great shape, growth is strong, the labor market is strong, inflation is close to target. That’s what you’re seeing.”

Still, traders were moved only a little by Powell’s optimism.

Two more hikes would translate to a target funds rate of 2.25 percent to 2.5 percent. But traders implied a 2.19 percent funds rate by December, which would get close to but fall short of the Fed’s intentions.

What will matter between now and then is data — how much more progress the economy makes toward a 2 percent inflation rate, and whether wage pressures will build that also would compel the Fed to act.

On the other hand, continued unrest in emerging markets and signs that the U.S. bank is getting out of step with the pace of its global counterparts could give officials pause.

Some economists believe the market’s skepticism about a more aggressive Fed is ill-founded.

“From the data we look at, there is every reason to believe the economy will more than justify the Fed’s proposed trajectory for policy rates,” Steve Blitz, chief U.S. economist at TS Lombard, said in a note to clients. “The trajectory for higher policy rates is in place. The market’s ‘bet’ against that happening is what looks wrong.”

After all, the U.S. is on the path to possible GDP growth of 4 percent or more in the second quarter that could last throughout the year. The Fed could justify tightening faster than other central banks simply on the grounds that the U.S. is growing much better than most other major developed economies.

Still, Tom Porcelli, chief U.S. economist at RBC Capital Markets, said “client chats” are indicating that “doubts remain.”

“Chairman Jay Powell used the word ‘great’ to specifically describe the backdrop twice and he used ‘strong’ about a dozen times,” Porcelli said in a note. “Any doubts about their conviction on the path they see this hiking cycle taking should be long extinguished.”

Source: CNBC