Sunday, December 31, 2017

Question #5 for 2018: Will the Fed raise rates in 2018, and if so, by how much?

by Bill McBride on 12/31/2017 01:41:00 PM

Earlier I posted some questions for next year: Ten Economic Questions for 2018. I'm adding some thoughts, and maybe some predictions for each question.

5) Monetary Policy:  The Fed raised rates three times in 2017 and started to reduce their balance sheet. The Fed is forecasting three more rate hikes in 2018.  Some analysts think there will be more, from Goldman Sachs:

"We expect the next rate hike to come in March with subjective odds of 75%, and we continue to expect a total of four hikes in 2018."
Will the Fed raise rates in 2018, and if so, by how much?

For years, following the great recession, I made fun of those predicting an imminent Fed Funds rate increase.  Based on high unemployment and low inflation, I argued it would be a "long time" before the first rate hike.   A long time passed ... and in 2015 I finally argued a rate hike was likely.

The Fed raised rates once in 2015, and then once again in December 2016, and then three times in 2017.   Currently the target range for the federal funds rate is 1-1/4 to 1‑1/2 percent.

There is a wide range of views on the FOMC.  As of December, the FOMC members see the following number of rate hikes in 2018:

25bp Rate Hikes
in 2018
One Rate Cut1
No Hikes1
More than Four1

The main view of the FOMC is three rate hikes in 2018.

As the economy approaches full employment, and with the new tax law adding a little stimulus, it is possible that inflation will pick up a little in 2018 - and, if so, the Fed could hike more than expected.

Tim Duy wrote Thursday: 5 Questions for the Fed in 2018
Is this the year inflation begins to pick up?
Will job growth slow as expected?
Are policy makers underestimating the impact of the tax cuts?
Should the Fed care about inverting the yield curve?
Will financial stability concerns affect rate policy?
... as we think about these issues, note that the Fed will be navigating these waters with a new captain as Chair Janet Yellen is succeeded by Governor Jerome Powell. Plus, there will be a new crew in the form of Randy Quarles and, if confirmed, Marvin Goodfriend. Moreover, the more dovish voting members of the Federal Open Market Committee such as December dissenters Kashkari and Charles Evans rotate off in favor of the more hawkish voices such as John Williams and Loretta Mester. On net, the Fed will find more reasons to hike rates than hold steady in 2018, leaving the current three hike projection as the best bet.
My current guess is the Fed will hike three times in 2018.

As an aside, many new Fed Chairs have faced a crisis early in their term.   A few examples, Paul Volcker took office in August 1979, and inflation hit almost 12% (up from 7.9% the year before), and the economy went into recession as Volcker raised rates.   Alan Greenspan took office in August 1987, and the stock market crashed almost 34% within a couple months of Greenspan taking office (including over 20% in one day!).  And Ben Bernanke took office in February 2006, just as house prices peaked - and he was challenged by the housing bust, great recession and financial crisis.

Hopefully Jerome Powell will see smoother sailing.

Here are the Ten Economic Questions for 2018 and a few predictions:

Question #1 for 2018: How much will the economy grow in 2018?
Question #2 for 2018: Will job creation slow further in 2018?
Question #3 for 2018: What will the unemployment rate be in December 2018?
Question #4 for 2018: Will the core inflation rate rise in 2018? Will too much inflation be a concern in 2018?
Question #5 for 2018: Will the Fed raise rates in 2018, and if so, by how much?
Question #6 for 2018: How much will wages increase in 2018?
Question #7 for 2018: How much will Residential Investment increase?
Question #8 for 2018: What will happen with house prices in 2018?
Question #9 for 2018: Will housing inventory increase or decrease in 2018?
Question #10 for 2018: Will the New Tax Law impact Home Sales, Inventory, and Price Growth in Certain States?