Last week was always going to frame the macrothematics of 2018 however last week has done more than that; its framed the next 36 months.
As we all expected Federal Funds Target Rate was raised by 25bps to 1.75%. However, what was more important was the possibility of four rate rises in the 2018 and therefore all attention was on the dot plots.
The initial read was that the forecasted three rises for this year remained a more dovish look and markets reacted according leading to bond yields easing. Yes, the initial fall in yields was down to the Fed’s slightly lighter hawkish stance in for 2018. But the major reason that drove the yields lower is geo-political risk. The Trump administrations latest set of tariffs which are squarely aimed at China and are clearly not the last set coming, are adding a level of risk in market not seen in 5 years – White House remains in my view the single largest risk factor facing markets and has altered the growth outlook
However retuning to the initial reaction to the dot plots what is clear is that it missed the changes in the forecasts for 2019 and 2020 – which are clearly hawkish.
This is the chart shows the December projections versus the March projections
The steeper 2019 and 2020 projections are clear signs of a more hawkish Fed, it gives the Board latitude to bringing rate rises forward and to be even steeper in bp hikes. There is clearly still a case for four rate rises in 2018 and the dot plots suggest there is every chance a 2019 forecast could be brought into this year.
The reason for highlighting the plight of the US interest rate market is the effect its having on Australian funding.
The increasing US money market rates is causing short dated Australian rates to spike. As the chart illustrates the 3-month bank bill swaps rate is at its highest level since Mid-2016. The 50bps of cuts the RBA brought in in May and August of 2016 are now being completely negated.
The impact this will have on funding over the coming 18 to 36 months is acute, and if the FOMC raises rates as forecasted there is every chance short term rates will be north of 2.5% coming this time next year.
This cost impact will hit earnings, it will likely lead to cost pressures that will filter through to the consumer (mortgage holders, margin lending and the like) and will crimp growth in general – this will be a major theme for the coming years.