The Fed’s rate-hike cycle is nearly complete
The Fed has already raised rates eight times in this cycle, starting in December 2015. We believe it will raise rates again in December 2018, bringing the total to nine hikes for this cycle and resulting in a fed funds rate of 2.25%-2.50% (see Exhibit 2). Beyond 2018, our expectation is that the Fed will likely raise rates one or two times, and then perhaps pause to assess the economic data and impact. The market expectation for 2019 is currently for one more rate hike, while the last set of Fed median estimates indicates three more rate hikes in 2019.
Regardless of which camp is correct, the key point in our view is that the Fed’s cycle is close to the end: nine rate hikes have been completed, and there may be between one and four left. As a result, the majority of the market’s adjustments are behind us. While it is true that, historically, Fed cycles have often led to recessions (10 out of the last 13 cycles since the second world war), recent commentary from Fed officials, including Fed Chairman Jerome Powell, indicate that this Fed will be prudent and data-dependent, proceeding cautiously as it winds down this cycle.
Exhibit 2: Fed funds rate (upper bound),%
Source: Bloomberg. Data as at 30/11/2018.
While the rate-hiking portion of normalisation is nearly complete, balance-sheet normalisation is ongoing. The Fed so far has reduced its balance sheet by approximately USD 400 billion, from USD 4.5 trillion to USD 4.1 trillion1 , and estimates are that it will ultimately cut its holdings by another USD 1.0 trillion to USD 1.5 trillion.
As a result, with more Treasuries coming to market over the next few years – and with rising deficits in the US – we are closely watching changes in long-term Treasury yields, which may be pushed upwards by these two forces over time. (However, bond yields have most recently been falling, as growth concerns have become prevalent.)