The Federal Reserve’s Decision: A Brief Evaluation

27 Eylül 2018

The FOMC raised the funding interest rate by the expected 25 basis points to the range of 2-2.25%, reaching the highest level since the onset of the Global Crisis associated with the collapse of Lehman Brothers in October 2008. For the first time, the expected real interest rate has moved out of the negative territory. Moreover, it has been confirmed that there will be another 25 basis points increase in the December meeting, as expected by 12 out of 16 FOMC members.

According to the dot plot graph reflecting the expectations of FOMC members about the future path of interest rates, the median expectation for the funding rate at the end of 2019 was in the range of 3-3.25%. This corresponds to three 25 basis points rate hikes next year.

Expectations for 2020 are more widespread, but the average remains the same as the previous estimate at around 3.4%, with a median range of 3.25-3.50%.

While the Committee’s growth expectations for 2018 were revised upwards from 2.8% to 3.1%, those for 2019 were slightly increased from 2.4% to 2.5%, while remaining steady at 1.8% for 2021.

Prior to the FOMC decision, the 2-year US Treasury bond yield, previously at 2.85%, dropped to 2.81%, while the 10-year bond yield, previously at 3.1%, eased slightly below to 3.05%. Starting the day at 94.17, the USD index (DXY) slipped to just under 94 before rebounding to 94.3.

The removal of the phrase “the stance of monetary policy remains accommodative” from previous announcements and Chairman Powell’s statement during the press conference, “The performance of the emerging market economies really matters to us in carrying out our domestic mandate,” were perceived by the markets as a dovish message.

Investors who experienced significant losses in EM assets from April to September are inclined to overly interpret the Fed’s communication positively to make up for their losses and close the year in positive territory – a tendency we have seen many times in the past. Without a permanent solution to the USD liquidity problem in EMs, it seems unlikely that gains will be sustainable. However, it is understood that market reaction will be positive tomorrow, with EM assets showing a strong performance. In this context, it should be expected that TRY assets will rise, and the TRY will appreciate, especially considering the perception that political tensions have eased, providing a temporary favorable environment that could be utilized as an opportunity to close foreign currency debts.