Fed Maintains 'Hovish' Stance But More Rate Hikes Expected In 2016

by: Kevin Mahn

Summary

The Fed would like to adopt more of an increasingly hawkish stance given solidifying economic data in the U.S. and mounting inflationary pressures.

They continue to strike somewhat of a dovish tone to appease certain vocal dissenters and those concerned with global economic growth altogether.

We are introducing the “hovish” term to describe this current hybrid state of hawkish/dovish positioning by the Fed.

The next rate hike likely will take place in June and the following hike in late summer/early fall before the presidential election cycle really starts to heat up.

Following their meeting this week, the Federal Reserve (Fed) chose to leave interest rates unchanged again. While we believe that the Fed would like to adopt more of an increasingly hawkish stance given solidifying economic data in the U.S. and mounting inflationary pressures, it seems that they continue to strike somewhat of a dovish tone to appease certain vocal dissenters and those concerned with global economic growth altogether - though they did indicate in the current release that international factors were no longer as much of a concern by removing the previous wording of, "global economic and financial developments continue to pose risks."

Hence, we are introducing the "hovish" term to describe this current hybrid state of hawkish/dovish positioning by the Fed. It should be interesting to see if others start to adopt our new nomenclature as well.

Based on outtakes from the Federal Open Market Committee (FOMC) meetings, I currently believe that there will be 2 - potentially 3 - additional rate hikes of 25 Basis Points (i.e. 0.25%) in 2016, with the next hike likely taking place in June and the following hike in late summer/early fall before the presidential election cycle really starts to heat up. This would result in a Fed Funds Target rate in the range of 0.75%-1.00% by the end of 2016.

Our forecast is slightly below that of the weighted 2016 target rate forecast of the Fed based on the last released forecasts of the FOMC participants stemming from their December 2015 meeting (see table below) but consistent with what many in the market now believe will be the likely path for this year. We will look to post more recent data in this regard once available.

2016 Target Rate

Number of Fed Participants

% of Voting Fed Participants

Weighted 2016 Target Rate

0.875%

4

23.53%

0.21%

1.125%

3

17.65%

0.20%

1.375%

7

41.18%

0.57%

1.625%

2

11.76%

0.19%

1.875%

0

0.00%

0.00%

2.125%

1

5.88%

0.13%

2.375%

0

0.00%

0.00%

2.500%

0

0.00%

0.00%

2.625%

0

0.00%

0.00%

Totals

17

100%

1.29%

Click to enlarge

Source: Board of Governors of the Federal Reserve System, Fed's Projection of the Midpoint Target Range or Target Level, December 2015.

One other notable research firm that our forecast is well below is Capital Economics as they stated in their "U.S. Chart Book" on April 25, 2016, that they expect the next rate hike to be in June, with the fed funds rate reaching 1.00% to 1.25% by this year-end, and 2.25% to 2.50% by the end of 2017.

Looking to next year, the weighted Fed Funds target rate for 2017 currently calculates to a rate of 2.29%, though we presently believe that the target rate will likely be closer to 1.75%-2.00% by the end of 2017.

As a result, based on current data and forecasts, it is fair to conclude that interest rates will remain at historically low levels for the foreseeable future.

We, at Hennion & Walsh, also still contend that going forward, the Fed will likely follow the blueprint that it utilized during the 2004-2006 tightening period when it gradually raised the Federal Funds Target Rate on 17 different occasions in 25 Basis-Point increments over this time frame.

The only difference during this round of tightening that we see is that the Fed may also consider starting to slowly shrink the size of their U.S. Treasuries and Government Agencies securities laden balance sheet, in conjunction with increases to the Federal Funds Target Rate.

In other words, instead of just considering raising rates further after each FOMC meeting, they may eventually consider some form of a gradual 1-2 punch of rate increases and sales of U.S. Treasuries (or non-reinvestment of the principal of existing maturing bonds) off of their balance sheet… though not necessarily after each FOMC meeting.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.