The Federal Reserve’s move to hike interest rates by 25 basis points, only the third hike in over 10 years and second in three months, marks the beginning of a new phase of US monetary policy normalisation, says Fitch Ratings.
Fitch said the recent US rate hikes could mark the beginning of a significant shift in the global interest rate environment, with benchmark US policy rates settling higher over the long-term than current market expectations.
“The prediction for three hikes in 2017 in the Federal Open Market Committee’s (FOMC) December 2016 Summary of Economic Projections was initially met with some scepticism in financial markets.
“However, by moving rates up again so quickly, the Fed now looks well on track to deliver. Two rate hikes within the space of just over three months and some marginal toughening up of the statement on forward guidance underscore the contrast with the glacial and hesitant approach to unwinding stimulus seen in the past few years,” it said in a statement.
Raising the Fed Funds target rate to 0.75-1.00 per cent marks the second rate hike in just over three months.
Fitch said it expects a total of seven hikes in 2017 and 2018, bringing the policy rate to 2.50 per cent compared to two rate hikes between the end of 2008 and 2016.
“Macro indicators through the second half of 2016 and early 2017 reinforce the likelihood of a pickup in rate normalisation over the medium term,” it said.
The US GDP growth of 2.6 per cent in the second half of 2016 is a significant recovery from the first half, underpinned by improvements in private investment and industrial output, besides supportive job data.
“Material fiscal easing should bolster positive domestic demand trends. President Donald Trump’s agenda of tax cuts, fiscal stimulus and deregulation in the financial services and other sectors strongly indicate that some level of growth boost is likely,” it said.
Although the precise form of stimulus remains uncertain, Fitch believes that fiscal policy could add up to 0.3 percentage points to economic growth in both 2017 and 2018.
Fitch recently revised up its US growth expectations in recognition of the increased likelihood of fiscal easing, higher private investment and an improving global outlook.
Fitch forecasts US GDP growth to accelerate to 2.3 per cent and 2.6 per cent in 2017 and 2018, respectively.
The rating agency did not not believe that the increased pace of Fed rate hikes pose a risk to US economic growth.
However, the impact of dollar strengthening could have wider global effects, the statement said.
“US rate rises, combined with fiscal stimulus, at a time when the European Central Bank and Bank of Japan are continuing to pursue an ultra-loose monetary policy, should prolong the dollar strengthening trend. Rising rates and dollar strength have historically added to external financing risks for emerging markets,” it said.
Fitch also said market expectations for a permanently lower equilibrium interest rate in the US and the continuation of an ultra-loose monetary policy for several more years could be increasingly challenged.