The US Federal Reserve hiked interest rates at the September meeting, as widely expected. The overall tone was upbeat, although Chairman Jerome Powell chose to strike a relatively dovish note at the press conference, presumably making room for more flexibility around the future policy path given the multitude of uncertainties.
Very high bar
For now, activity strength continues and inflationary and wage pressures are becoming more broad-based, giving the Fed enough confidence to carry on with its hiking cycle. While trade tensions have risen over the past few weeks, affecting sentiment to some extent, there has not been enough evidence to suggest tariffs are having a significant negative impact on the economy, at least for now.
With the fiscal stimulus set to continue boosting growth through the first half of 2019, the bar for the Federal Open Market Committee (FOMC) to change its message or steer away from the policy path communicated via the so-called dot plot of individual members’ expectations is currently very high.
However, as the fiscal boost starts to wane and broad financial conditions tighten further, growth should decelerate towards trend - potentially quite quickly - around the middle of 2019, as the economic cycle matures. While the dot plot suggests a fourth hike this year and three more next year, this is likely to prove too aggressive for the US economy, especially considering that the net impact of quantitative tightening running in the background is still ambiguous.
This tightening is also likely to prove too much for the rest of the world. Emerging market economies, in particular, have faced tighter financial conditions already this year, allowing vulnerabilities to resurface as capital flows started reversing.
So far, the related stress in countries such as Turkey has remained quite isolated, but as global liquidity tightens further, such stresses could become systemic. With trade war rhetoric unlikely to de-escalate any time soon, the overall risks to US and global growth are clearly skewed to the downside.
This means the Fed will have to strike a more cautious tone, slowing the pace of tightening next year - but we are not there yet.