EUR 850.00 For Business Accounts Only

Morningstar | Fed Tightens Again, Removes 'Accommodative' Wording; Economic Signals Remain Strong For Now

As expected, the Federal Open Market Committee voted to raise its target rate range to 2.00%-2.25% during its September meeting. The vote was unanimous. Economic data remains positive for the U.S., with unemployment remaining quite low, household spending and business investment remaining constructive, and real GDP growth expected to be above 3% for 2018. The FOMC’s statement maintained essentially all its language, upholding that further hikes would be gradual and that the risk outlook remains roughly balanced. However, we did notice that the committee removed language that had previously stated that the stance of monetary policy remains accommodative. This suggests to us that the FOMC is getting closer to what it views as a neutral rate in the current environment, and may not be certain they are still being accommodative even as the market still expects many more rate hikes. Overall, even as our medium-term rate forecasts may change, our long-term rate projection remains intact, and we would expect overall net interest margins to increase at a reduced pace regardless, as competition picks up among banks. Therefore, we are leaving current fair value estimates in place for all of our banks.

The most rate-sensitive names we cover remain Comerica and M&T, but we believe the market largely understands this already, and we view the names as fairly valued. Instead, we still see some value in Wells Fargo, given the pessimism and poor headlines continuing to plague the bank. Further, with banks in general simply treading water for 2018 year to date, we are beginning to see our broader coverage as more fairly valued today than we did at the start of the year.

CME data suggests the market expects another rate hike at the December meeting, at least one hike by the June 2019 meeting, and likely at least one more hike before the end of 2019. This lines up with the new “dot plot,” which had more dots moving higher in all years, including for the longer run-rate projection. This would bring the target rate up to 2.75%-3.00% by the end of 2019. This rate is what we have been projecting as the long-term normalized rate, and would occur nearly two years before we had originally expected. For 2021, a new year not available in the last dot plot release, there is a rough midpoint range of 3.25%-3.5%, higher than the projected long-term rate. We believe that borrowing costs to consumers and businesses will begin moving up at an accelerated rate, and with the initial boost from tax reform likely to have worn off in 2019, we wouldn’t be surprised to see continued quarterly rate hikes becoming a key headwind for the economy even as early as 2019. With many wondering what will derail the long economic recovery and the extended bull market since the crisis, we believe this is a key story to watch. We will update our medium-term rate forecast as hikes continue to occur. However, given the potential risks we see to the economy and with inflation remaining well controlled, with core-PCE coming in at 2.0% year over year in July, we would not be surprised if rate hikes don’t go much above the 2.75%-3% level once they get there. This would be in line with our long-term forecasts.

For a more detailed view of the factors driving our interest rate expectations, please see our September 2016 Observer, "Solving the Interest-Rate Equation."