4. Policy was tightened four times last year. The Fed raised rates three times in 2017 (as well as once in December 2016). It also started to shrink its balance sheet. That’s four cases of policy tightening. The economy is in better shape now and inflation will likely be higher, so it’s hard to see why the Fed would be even slower to tighten in 2018 than it was last year. The Federal Open Market Committee (FOMC) still describes its tightening cycle as “gradual,” but slowing the pace to two hikes in 2018 would be even more gradual—despite a stronger economy and markets.
5. The Fed doesn’t want markets to overheat. Several FOMC members have expressed concern that a too-accommodative monetary policy could contribute to financial-market excesses and asset-price bubbles. We’re not worried yet that bubbles are emerging (neither is the Fed), but rate hikes that tighten conditions would reduce that risk. And with the economy strong enough to handle higher interest rates, pulling the reins in a bit on financial markets makes sense.
And One Reason We Might Be Off the Mark
We think there’s a strong case for tighter monetary policy in 2018, but there are always risks that could upend both the economy and our expectations. Political turmoil in Washington is the biggest wild card—as highlighted by the recent (and thankfully brief) government shutdown.
Whether it’s a longer shutdown down the road, a debt-ceiling cliffhanger or turmoil surrounding November midterm elections, we still see politics as the single biggest risk to the expansion. If political risks play out in a disruptive way, it would make the Fed much less likely to raise interest rates as much as we think they will.
But as things stand now, we’re confident in our assessment. The economy is striding along and has shrugged off political developments to this point; our base-case forecast is for it to stay that way. That should set the stage for the Fed to hike four times this year—more than the market expects.
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