Federal Reserve set to raise rates, signal slower pace of hikes
The Federal Reserve is heavily expected to raise interest rates again at their next monetary policy meeting today, although they are likely to signal that additional rate increases will occur at a much slower pace in 2019.
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t the September FOMC meeting, when the most recent set of economic projections were released, policymakers indicated that they were anticipating hiking rates on roughly three occasions in the US next year (Figure 1). These expectations have, however, been dialled back by the market in the past few weeks following unambiguously dovish communications from Fed Chair Jerome Powell.

Figure 1: FOMC September ‘Dot Plot’ [26/09/2018]

Source: Federal Reserve/Thomson Reuters Datastream Date: 18/12/2018
Speaking at an event in New York in late-November, Powell stated that the current policy rate was ‘just below’ the estimate of the neutral level of interest rates. This projected ‘neutral’ level is deemed the rate at which both inflation remains steady and the economy is growing at its long-term trend rate. His comments represent a significant departure from previous commentary of his as recently as October, where he had stated that the Fed funds rate was ‘a long way’ from such levels. This is a significant development that suggests that the Fed may be ready to pause on their rate hike cycle or, at least, considering raising rates at a much more gradual pace than had been indicated back in September.

That being said, we still think that the Fed will raise rates by another 25 basis points on Wednesday. With an interest rate hike from the Fed around 70% priced going into the meeting, currency traders will, as is generally the case, be focusing heavily on the release of the latest ‘dot plot’.

Given Powell’s recent comments, we think that the dot plot, which is a representation of where each voting member of the committee expects rates to be at the end of the year, is almost certain to be revised lower. We think that it may well show an average of just one hike in 2019 from the three pencilled in back in September.

How will the US Dollar react to the Fed announcement?



Following Powell cautious comments, fed fund futures are now only pricing in one US rate hike in 2019 in the final quarter of next year, as per Figure 1. We think that this is a reasonable assumption and think that the Fed will pause it's hike cycle for at least the next couple of quarters, before reassessing the need for additional hikes based on upcoming inflation prints. This means we are now calling for stable rates in 2019 with no Fed hikes at all or, at most, just one hike towards the latter stages of next year.

As this is now largely priced in by the market, a more modest downward revision in hike projections could actually prove to be a US Dollar positive on Wednesday. If the Fed surprises, holds its current course and continues to signal three more hikes in 2019, we could see a sharp rally in the greenback in the second half of this week.
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