The U.S. Federal Reserve moved up its tapering timeline and is now projecting at least three rate hikes next year in response to hotter-than-expected inflation. Anthony Okolie speaks with Scott Colbourne, Managing Director, Active Fixed Income, TD Asset Management, about the implications for the U.S. economy.
Anthony, today's meeting was... we had a little slight hawkish surprise. I think the first thing that we focused in on it was that transitory inflation has gone and they did announce a taper. So most of the focus of today's meeting was on the summary of economic projections. But by and large, the markets have taken today's announcement pretty much in stride.
The Fed also acknowledged that it no longer views inflation as transitory and it could pose a bigger risk to the economy. Do you agree with this assessment?
Yeah, I think that language has been long overdue to be shelved, and Governor Powell mentioned earlier that it was to be retired at this meeting, so it's gone from the language of the press release and that's appropriate. Obviously, we've got inflation and recently in print since the last meeting when they announced tapering, where the inflation prints have been higher than expected. So we needed to put that in the back burner, back behind us to really allow the Fed to adjust its tapering and adjust its rate projections going forward.
And in the meeting the Fed also is now signaling at least three rate hikes next year, but they also plan to keep the rates at near zero until a maximum employment is reached. Scott, what are your thoughts?
Yeah, so as I sort of alluded to earlier, the meat of today's meeting is all centered around the summary of economic projections. So they updated it. The last time we had it was in September. This meeting, we got an update on their forecasts for GDP, on the forecast for inflation employment and a note on dot plot. So what we saw was a slightly higher uptick on inflation, so 2.7 for next year. And that is obviously higher than where central banks sort of focus on around the 2, 2.25 level for inflation. So inflation running a little hotter comes down thereafter going forward and economic growth was revised down. And that is mildly in line with the evolving outlook, the economic outlook and slightly higher interest rates. So those were two major changes. But I think the focus of the markets were all around the dot plots. And so we went in looking for two hikes next year. The median was for two and we got three. And that was a surprise to the markets. That was the mildly hawkish expectation or focus of the market today. We got another three for 2023. Surprisingly, though, we got only two hikes in 2024. So net net, we've got basically eight hikes priced in over the next few years. And obviously that's an increase up from about six and a half rate hikes from the September projection. So net net, slightly higher. But at the end of the day, as I said earlier, the market reaction has been kind of muted. We've got slightly higher front end bond yields. Currency markets are pretty stable. Equity markets are pretty stable. The credit markets are pretty stable. So it appears that the Fed has acknowledged higher inflation. They've shifted up the rate hikes, but they sort of thread the needle on managing the market's expectations around managing risk assets all in all.
Scott, what are some of the risks to the Fed's outlook in the near term? And what will you be watching closely over the next few months?
Yeah, I think the interesting thing is that the Fed did acknowledge that COVID continues to shape the outlook for the economic development globally. It's having a profound impact on our forecast. It's raising the degree of uncertainty. We've talked a lot about that and raising the degree of volatility in the markets. And so it's heightened policy uncertainty. So that's the real key. We don't have a lot more clarity on that, so that's a big focus of the market. And I think that while the Fed may be saying that, look, we're going to go for eight hikes over the next three years. The market's sort of pushing back on that. We look at what we call estimates of terminal rates. In the US it's only about 1.5%, so there's a bit of a divergence between what the markets are focusing on. Even after today's announcement and with the Fed looking for longer term. So maybe a front loaded rate hike cycle and then it tapers off pretty quickly after that. So those are the two things that I'm really focusing on, how the markets are evolving in terms of rate expectations and how the markets are dealing with the uncertainty.
Scott, thank you. And I just want to get your final thoughts on the US dollar. Where did you see it going in the next little while?
Going into this, the markets had sort of expected a slightly more hawkish Fed and the US dollar had been bid up. And I think that what we've got is a confirmation of that. And typically in an environment of that, it's a bit of a "sell the fact". So we've got actually a little bit of a US dollar stability sell off in this environment. Net net, we're going to focus on relative differentials between monetary policy, probably. So Canada and the Fed are sort of in line. Other markets, perhaps in Europe, the U.K., not quite as hawkish. So there's going to be a slight divergence between currencies. So I still think the Canadian dollar is stable here. And as both the Bank of Canada and and Fed hike into the end of the year and into next year.
Scott, thank you very much for your time.
My pleasure. Thanks, Anthony.