As expected, the Federal Reserve, headed by the new chairman Jerome Powell, raised interest rates for the sixth time since the financial crisis by 0.25% to 1.50-1.75%. The central bank hinted at gradual hikes for this year with two lift-offs but turned hawkish for 2019 and 2020, citing growing confidence in the strengthening economy.
The Fed is cautious about rising trade tensions. Trump has recently announced tariffs on steel and aluminum imports and is seeking to slap a series of tariffs on China imports, targeting the technology, telecommunications and apparel sectors that could hit $60 billion goods in the world’s second-largest economy. The action could lead to threats of retaliation or even a trade war.
However, Powell signaled for faster rate hikes for the next few years as the massive $1.5 trillion tax cut and a bipartisan $300-billion spending plan could overheat the robust labor market, flaring up inflation and calling for aggressive policy tightening. The Fed now sees a total of eight quarter-point hikes in the fed-funds rate through the end of 2020 to near 3.4%. This includes three increases this year, including the latest move, three in 2019, and two in 2020.
The Fed raised the economic growth forecast to 2.7% this year from 2.5% and 2.4% for 2019 from 2.1%. Inflation is expected to stay at 1.9% this year and return to the Fed’s target of 2% in the next. Additionally, unemployment rate, which is at 17-year low of 4.1%, is expected to fall further to 3.8% at the end of this year and 3.6% at the end of the next.
Higher Rates: A Reason to Worry
Higher rates would attract more capital to the country, thereby boosting the U.S. dollar against the basket of other currencies. This would leave a huge impact on commodity-linked investments, reflecting that a rising rate environment will hurt a number of segments. In particular, high dividend paying sectors such as utilities and real estate would be the worst hit given their higher sensitivity to rising interest rates.