Lombar Odier Comments on FOMC decision

As widely expected, the FOMC decided to hike its policy rate by 25bp to a range of between 2-2.25%. However, the committee removed the reference that monetary policy remains accommodative, signalling that the FOMC believe that the policy rate is getting closer to neutral.

Nevertheless, the Statement makes it clear that further tightening will be required, but could start to indicate more flexibility in the timing of the next hikes, likely in light of some increases in uncertainties (mainly the impact of an escalation a trade war), even though the FOMC’s forecast is little changed.

We continue to believe that the Fed will hike at the December meeting. However, in our view, the focus of investor regarding the Fed policy is shifting to what is the probability of the Fed going too far in its tightening cycle and initiate the next recession rather than the timing of the next hike. This is the reason why investors have been so focused on the shape of the flatness of the yield curve in recent weeks and with today’s decision it is likely to remain the case. However, as we wrote some weeks ago, we are still far from the moment when the yield curve would inverse, a reliable leading indicator of recession since the 1960s. First, the yield curve may have been distorted but the Fed’s QE and Operation Twist, pushing the longer end lower. Second, if we consider the current level of real rates and leading indicators, in addition to the yield curve, our estimated probability of a recession is close to zero.

We believe that the Fed will continue its policy tightening in response to continued increase in underlying inflationary. But an inversion of the curve is unlikely to happen until mid-2019; meaning that a US recession is very unlikely over the next 12 months, barring a shock to the US economy.

 Charles St Arnaud – senior investment strategist – Lombar Odier IM