Interest Rates Monitor

The US Federal Reserve raised its target interest rate by 25bps last month to be in the range between 2.00% to 2.25%. Following suit, central banks in the GCC also raised their benchmark rates by roughly the same amount. After eight rate hikes so far in the US and over nine years of economic expansion, it is logical to assess where we are in the cycle and where interest rates are heading.

Looking at the strength of the US economy and barring any unexpected shock, we think there is sufficient scope in the current cycle for three to four more rate hikes. This is slightly lower than the Fed’s projection of five more rate hikes between now and the summer of 2020 and is attributed mainly to our view that the US GDP growth will lose momentum in 2019.

Fed Watch

The Federal Reserve’s median dot plot for 2018 indicates one more hike in December, three in 2019 and one in 2020.  The recently introduced projection for 2021 reflects rates to be the same as that in 2020 i.e. 3.4%. In September, the Fed also revised the long run - median rate slightly upward from 2.875% to 3.0%. We think this may largely be due to inclusion of one more vote (after Vice-chair Richard Clarida was included), rather than any material change in existing voters’ views.

The Fed raised the forecast for GDP growth in 2018 to 3.1% from 2.8% previously. Growth estimates for 2019 were also revised marginally upwards to 2.5% from 2.4%, settling at around 2% in 2020. The unemployment rate forecast for this year was revised higher by 0.1 pp to 3.7%, and 2021 shows a tick higher in unemployment. Though unemployment level is projected to increase slightly, there appeared stronger conviction around inflation to reach and exceed the Fed’s target level of 2% in the short to medium future.

The FOMC removed the word "accommodative" from its September meeting statement which was perceived to be dovish and some investors began to price in the possibility that the Fed will slow its rate hike trajectory from here. However, given that real rates in the US still remain negative, we think that the Fed will remain committed to raising rates over the next two to three quarters.

Fed's projected rate hikes vs the market

Source: Bloomberg, Emirates NBD Research

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