FOMC meeting update: Fed holds fire ‘til Christmas

In a week dominated by frenetic coverage of the US mid-term elections and the policy uncertainty created by the Democrats reclaiming a majority in the House of Representatives, the predictability of the US Federal Reserve’s Federal Open Market Committee was welcomed.

As expected, the 12-member committee which, like the UK’s Monetary Policy Committee (MPC), assesses economic and financial conditions to decide whether it should change interest rates, kept rates on hold.

It also made only minor changes to its outlook. While Fed chair, Jerome Powell, recognised the lower unemployment figures reported over the past two months as well as slightly softer business investment in the third quarter, he once again highlighted ongoing strong economic activity and noted that inflation remains near 2%.

In addition, the Committee indicated that the direction of travel, which saw it raise US interest rates by 0.25% in September, remains upwards: “The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labour market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term.”

US GDP growth in the third quarter (Q3) came in at 3.5% on an annual basis, only modestly slower than the 4.2% recorded in Q2. And markets expect this solid momentum to continue into the early stages of 2019, with fiscal easing likely to continue to boost activity – albeit to a smaller degree than in 2018.

The September hike was the third of 2018 and the ninth since December 2015, when the FOMC raised the Fed’s target funds rate for the first time in almost a decade. This was something of a monumental rise following the financial crisis and subsequent recession and unprecedented period of monetary easing.

It also represents quite a turnaround for what remains the world’s largest economy. Go back just three years and it’s easy to forget that the first rise from 0.25% to 0.5% was met with suspicion in some quarters as many feared the economic environment was still simply too fragile.

The Fed’s actions have been a boon to equities, with the S&P 500 in a prolonged bull market. What happens next, of course, remains to be seen. However, given that US wage growth has hit its best pace for years, the economy is showing decent momentum and employment figures remain strong, more hikes are expected. December may well see another rise but currently the general consensus, given the upbeat rhetoric from the Fed, is that investors could potentially witness three more rises in 2019. 

Quantitative easing certainly helped to prop up the flagging US economy. As Lehman Brothers collapsed in September 2008, the Fed’s balance sheet stood at just $905bn, which was 6% of GDP. It is now being wound down from a peak of $4.5trn, which represents around a quarter of US GDP[1]

As of October 2017, the Fed began to unwind this process, letting billions of dollars of securities mature each month without reinvesting them. From that point, it gradually increased the amount of maturing bonds.