Two months after the Federal Reserve hiked its key federal funds rate to a range of 1.5 to 1.75 percent, it appears they were just getting warmed up.
Financial industry experts say that with the Federal Reserve’s Open Markets Committee set to meet next week, Wall Street is already locking in yet another rate hike. In fact, more than one economist thinks the Fed will keep going and wind up hiking rates four times in 2018.
“The market and economy should be able to handle the increasing odds of a fourth rate hike,” said Jason Pride, chief investment officer of private clients at Glenmede.
The committee meets Tuesday and Wednesday.
Current pricing in federal funds futures markets implied a 53 percent chance of four or more rate hikes in 2018, as well as a 95 percent chance of a rate hike in June, Pride noted.
“Rising inflationary pressures and still-low interest rates are key reasons for this likely move by the FOMC,” he added.
Tightening monetary policy is typical for this stage of the economic cycle, Pride explained.
“The U.S. economy is in the later stages of its expansion (now nine years long) after near-full employment, and inflationary pressures are appearing on the margin, giving the Fed further room to normalize interest rates,” he said.
Other industry insiders are also on board for four interest rate increases.
“The odds of four rate increases have been inching higher and now spiked to over 60 percent,” said Bryce Doty, senior portfolio manager at Sit Fixed Income Advisors. “Part of it is simply math and how difficult it is for fed fund futures to accurately predict anything past six months so as time passes, the odds of the fourth increase in December has been naturally rising.”
The bigger factor, however, is a growing confidence in the strength of the economy and the lack of a good reason for the Fed to pause, Doty said.
“If anything, the market is beginning to feel the Fed could fall behind the curve on fighting inflation by moving too slow,” he said.
Economic data points and political considerations will weigh heavily on any short-term Federal Reserve decisions on interest rates.
“The Fed is very data driven and the economic data will dictate if, and how quickly, the Fed moves to increase interest rates,” said Robert Johnson, principal at the Fed Policy Investment Research Group in Charlottesville, Va.
Under former chair Janet Yellen, the Fed was very data driven and that will continue to guide current chairman Jerome Powell, Johnson said.
“One difference is that the current Fed faces a much more uncertain political environment than its predecessors,” he said.
The unpredictability of President Donald J. Trump with respect to both fiscal and foreign policy makes the formulation of the appropriate monetary policy much more difficult and could lead to changes in course, Johnson said.
Right now, the data points to a decidedly robust U.S. economy.
“The Fed has a dual mandate of stable prices and full employment,” Johnson said. “The unemployment rate fell to 3.9 percent in April from 4.1 percent in the previous month and was below market expectations of 4 percent.”
It is the lowest unemployment rate since December 2000.
Additionally, the annual inflation rate edged up to 2.5 percent in April from 2.4 in March, matching market expectations.
“That’s the highest rate since February 2017 amid rises in gasoline, fuel and shelter cost,” Johnson said. “We have seen steady increases in the inflation rate since the start of the year. If inflation continues to advance, I believe we will not see the Fed hesitate to raise rates.”
The Federal Reserve raised the target Fed funds rate at its March 21 meeting and elected to keep rates at that same level at its May 1-2 meeting.
“The overwhelming consensus of the market is that the Fed will raise rates,” Johnson said. “If it does so, it will have raised rates three times in a matter of seven months.
“I believe the Fed will likely raise rates three additional times this year,” he added. “This is not an unprecedented number of rate hikes. In 2005 the Fed raise rates eight times.”
Brian O'Connell is a former Wall Street bond trader, and author of the best-selling books, The 401k Millionaire and CNBC's Guide to Creating Wealth. He's a regular contributor to major media business platforms. Brian may be contacted at firstname.lastname@example.org.
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