Fed Now Hints at Four Potential Rate Hikes in 2018

As expected, the Federal Reserve increased interest rates for the second time this year, raising the Federal Funds Target rate on June 13, 2018 by 25 Basis Points (i.e. 0.25%). This leaves the Fed Funds Target Rate in a range of 1.75% – 2.00%. Their statement following the rate hike announcement was generally positive with the Fed noting that they believe that the economy is now rising at a “solid rate” (wording changed from “moderate rate” in their March statement) and household spending has picked up.

Federal Open Market Committee (FOMC) members also indicated that they expect core inflation readings to reach their target level of 2% by the end of 2018 and revised their annual GDP growth projection for 2018 upward to 2.8%. These areas of fresh economic optimism suggest that the U.S. economy is on a relatively stable footing and should help to diminish any shorter term recessionary concerns that investors may have.

However, what took some market participants by surprise after the rate hike announcement was the release of an updated “dot plot” chart from the Federal Reserve. The chart (see below) essentially shows the forecasts for the Federal Funds Target Rate of each of the FOMC voting members.

Source: CNBC, “Fed’s ‘dot plot’ points to four rate hikes this year, up from the three previously expected”, June 13, 2018.

Comparing the new dot plot chart to the one issued after the March meeting shows only minor changes. For example, one voting member changed their forecast from 2.00%-2.50% to 2.25% – 2.50% while two other members changed their forecast from 1.50%-1.75% to 1.75% – 2.00%. While these changes may seem insignificant across 15 total voting members, they did result in an overall 25 Basis Point (Bp) median forecast increase to 2.25% – 2.50%, suggesting that there may now be two additional rate hikes remaining in 2018 as opposed to just three.

However, before anyone assumes that four total rate hikes in 2018 are a foregone conclusion, it should be noted that 7 voting members (nearly 50%) have forecasts below the 2.25% – 2.50% range that would equate to two additional rate hikes this year. We also believe that the Fed is trying to carefully navigate this round of tightening by balancing increases to the Federal Funds Target Rate (which would tend to impact the shorter end of the curve) with balance sheet reductions of U.S. Treasuries (which would tend to impact the longer end of the yield curve). Recognizing, of course, that all future Fed activity is still predicated on future economic data releases, we contend that three total rate hikes in 2018 (in addition to three more potential rate hikes in 2019) still remain likely at this time in conjunction with additional balance sheet reductions. If this forecast holds true it would equate to one additional 25 Bp increase in 2018, coupled with the non-reinvestment of certain redeemed bond positions on their balance sheet, and the potential sale of additional balance sheet assets.

Regardless, investors, in our view at SmartTrust®, should appreciate that we are in a rising rate environment, with underlying favorable economic conditions, and position their portfolios accordingly taking into account their own specific objectives, risk tolerance and investment timeframe.

Disclosure: Hennion & Walsh Asset Management currently has allocations within its managed money program and Hennion & Walsh currently has allocations within certain SmartTrust® Unit Investment Trusts (UITs) consistent with several of the portfolio management ideas for consideration cited above.